20-F 1 a5152972.htm VOLVO CORPORATION 20-F Shell Company
As filed with the Securities and Exchange Commission on May 29, 2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
___________
FORM 20-F
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
for the fiscal year ended December 31, 2005
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
o
SHELL COMPANY PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-12828

AKTIEBOLAGET VOLVO (publ)
(Exact name of Registrant as specified in its charter)

VOLVO CORPORATION
(Translation of Registrant's name into English)

Kingdom of Sweden
(Jurisdiction of incorporation or organization)

S-405 08
Göteborg, Sweden
(Address of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of class
Name of each exchange on which registered
Class B, common stock
quota value SEK 6,
American Depositary Shares
each representing one Share
of class B common stock
NASDAQ

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:
 
A shares
131,374,699
B shares
273,088,810
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x  No o
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o  No x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes x  No o  Not Applicable o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer x     Accelerated Filer o      Non-Accelerated Filer o

Indicate by check mark which financial statement item the Registrant has elected to follow: 

Item 17 o  Item 18 x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o  No x
 
 

 
  3.A.
5
  3.B. Capitalization and Indebtedness
 8
  3.C. Reasons for the offer and use of proceeds
 8
3.D.  Risk factors
8
 
12
 
4.A. History and Development of Company
12
  4.B.  Business Overview
17
  4.C.  Organizational Structure
 33
4.D.
33
  ITEM 4A. UNRESOLVED STAFF COMMENTS
 34
  ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
35
 
5.A.
35
  Liquidity and Capital Resources 
40
  Research and Development, Patents and Licenses
46
  5.D.  Trend Information
46
  5.E.  Off-Balance Sheet Arrangements
47
  5.F. Tabular Disclosure of Contractual Obligations
 47
  ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
48
  Directors and Senior Management
48
  Compensation
54
 
54
  6.D.
54
 
55
  ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
57
  Major Shareholders
57
7.B.
57
  7.C.
58
  ITEM 8. FINANCIAL INFORMATION
59
 
59
  8.B.
60
  ITEM 9. THE OFFER AND LISTINGS
61
  Offer and Listing Details
61
  Plan of Distribution
62
  9.C. Markets
62
  9.D.
62
  9.E.
62
  9.F. Expenses of the Issue
62
 
62
  Share capital
62
  10.B.
63
  Material contracts
65
 
65
  10.E.
65
 
69
 
69
 
69
  Subsidiary Information
69
  ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
69
  ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
69
PART II  
70
  ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
70
 
70
  ITEM 15. CONTROLS AND PROCEDURES
70
  ITEM 16. A AUDIT COMMITTEE FINANCIAL EXPERT
70
  ITEM 16. B CODE OF ETHICS
70
  ITEM 16. C PRINCIPAL ACCOUNTANT FEES AND SERVICES
71
  ITEM 16. D EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
71
  ITEM 16. E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
72
 
1

 
 
2

 
 
 
Unless otherwise indicated, all amounts herein are expressed in Swedish kronor (“krona”, “kronor” or “SEK”) or in United States dollars (“dollars” or “US$”). Merely for the convenience of the reader, this Annual Report presents translations into dollars of certain krona amounts. Unless otherwise stated, such translations have been made at the noon buying rate of dollars in terms of kronor in New York City for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) on December 31, 2005, which was 7.937 kronor per dollar (0.126 U.S. dollars per krona). The Noon Buying Rate on December 31, 2005 differs from certain of the actual rates used in the preparation of the consolidated financial statements of Volvo, which are expressed in kronor, and therefore, dollar amounts appearing herein may differ significantly from actual dollar amounts which were translated into kronor in the preparation of those consolidated financial statements in accordance with accounting principles generally accepted in Sweden. See “Item 3. Key Information - 3.A. Selected Financial Data”. No representation is made that krona amounts have been, could have been or could be converted into dollars at the Noon Buying Rate on December 31, 2005 or on any other date as of which a convenience translation based on the Noon Buying Rate was 7.937 kronor per dollar (0.126 U.S. dollars per krona).
 
________________________________________________

As used herein, “Volvo”, the “Company” or the “Group” refers to Aktiebolaget Volvo and its consolidated subsidiaries and “AB Volvo” refers to Aktiebolaget Volvo, unless the context indicates otherwise. “Trucks” refers to the combined truck operations of the Volvo Group, consisting of the truck brands Mack, Renault Trucks and Volvo, which are individually referred to as “Mack Trucks”, “Renault Trucks” and “Volvo Trucks”, respectively.
 
________________________________________________
 
From January 1, 2005, AB Volvo prepared its consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union (“IFRS”). IFRS as adopted by the EU differ in certain respects from IFRS as issued by the International Accounting Standards Board (IASB). However, the consolidated financial statements for the periods presented would not be materially different had the Company applied IFRS as issued by the IASB. References to IFRS hereafter should be construed as references to IFRS as adopted by the EU. AB Volvo restated its financial statements from January 1, 2004 to IFRS. See Notes 1 and 3 to the consolidated financial statements. In addition, consolidated net income and stockholders’ equity are reported as reconciled to United States generally accepted accounting principles (“U.S. GAAP”). Unless otherwise indicated, all amounts and percentages presented herein are based on IFRS. IFRS as applied by the Company differs in certain significant respects from U.S. GAAP. For a discussion of the significant differences between IFRS and U.S. GAAP affecting AB Volvo’s consolidated financials statements and reconciliation to U.S. GAAP of consolidated stockholders’ equity and consolidated net income as of and for the years ended December 31, 2005 and 2004, see Note 37 to the consolidated financial statements. As a result of AB Volvo’s transition to IFRS reporting, certain amendments have been made to the adjustments recorded in its reconciliation of net income and equity under U.S. GAAP for the financial year 2004.
 
________________________________________________

At times, this annual report presents financial and other information for a specific year that is immediately followed by an amount within (brackets). This amount within (brackets) represents the corresponding amount for the previous year.
 
________________________________________________
 
Volvo owns or otherwise has rights (as described under the section “Patents, Trademarks and Licenses” below) to a substantial number of trademarks that it uses in conjunction with its business, including, but not limited to, the following trademarks mentioned in this Annual Report: “Volvo”, “Volvo Penta”, “Renault”, “Mack”, “Duoprop” and “Aquamatic” (see “Item 4. Information on the Company  — 4.B Business Overview — Patents, Trademarks and Licenses”).
 
________________________________________________
 
 
3

 

Certain information presented in this annual report on Form 20-F relating to the markets in which Volvo operates, such as the size of the particular market and the market share of Volvo within such markets, has been obtained by Volvo from market research reports, analysts’ reports and other publicly available information, as well as from internally developed market data. While Volvo has no reason to believe that third-party sourced information is not reliable, such information has not been independently verified. Accordingly, the accuracy or completeness of this information cannot be guaranteed.
 
 
This Annual Report on Form 20-F includes “forward-looking statements” within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended. Certain statements included in this Annual Report, including without limitations, those concerning (i) Volvo’s strategies, (ii) the economic outlook for the commercial transport equipment industries, (iii) expectations regarding prices, (iv) the development and commercial introduction of new products, (v) the quantitative and qualitative disclosures about market risk and (vi) Volvo’s liquidity and capital resources and expenditures, contain certain forward-looking statements concerning the Company’s operations, economic performance and financial condition. These statements can often be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “are expected to”, “will”, “will continue”, “should”, “seeks”, or “anticipates”. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove to have been correct. Accordingly, results could differ materially from those set out in the forward-looking statements as a result of, among other factors, (i) changes in economic, market and competitive conditions, (ii) success of business and operating initiatives, (iii) changes in the regulatory environment and other government actions, (iv) fluctuations in exchange rates and (v) risks inherent in business management.
 
Certain of these factors are discussed in more detail elsewhere in this annual report, including under “Item 3.D-Risk Factors” and “Item 5-Operating and Financial Review and Prospects”. Volvo undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or stock exchange regulation. It is not possible to foresee or identify all factors that could cause future results to differ from expected or historic results. Therefore, investors should not consider the foregoing factors to be an exhaustive statement of all risks, uncertainties or factors that could potentially cause actual results to differ from projections in this annual report.
 
 
4

 
 
 
Not applicable.

 
Not applicable.

 
 
The selected financial data set forth below as at and for each of the years ended December 31, 2004 and 2005 has been prepared in accordance with IFRS and derived from the consolidated financial statements of Volvo. See “Item 18 - Financial Statements”. The selected financial data set forth below as at and for the years ended December 31, 2001, 2002 2003, 2004 and 2005 has been prepared in accordance with U.S. GAAP and derived from the consolidated financial statements of Volvo. See Item 8 - Financial Statements.
 
This selected financial data should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated financial statements and notes thereto included in Item 18 of this annual report.
 

AMOUNTS IN ACCORDANCE WITH IFRS from 20041,
(In millions, except per share amounts)
 
2004 
3
2005
 
2005 
4
 
SEK
 
SEK
 
USD
 
Net sales
211,076
 
240,559
 
30,309
 
             
Net sales from continuing operations
211,076
 
240,559
 
30,309
 
             
Operating income
14,679
 
18,151
 
2,287
 
             
Net income
9,907
 
13,106
 
1,651
 
             
             
             
Net income per share5
23.58
 
32.21
 
4.06
 
Diluted income per share
23.55
 
32.16
 
4.05
 
             
             
             
Cash dividends per share6
12.50
 
16.75
 
2.11
 
             
Total assets
223,968
 
257,135
 
32,397
 
Non-current liabilities
45,064
 
48,814
 
6,150
 
Shareholders’ equity
70,155
 
78,768
 
9,924
 
             
Share capital
2,649
 
2,554
 
322
 
Weighted average number of shares. (in thousands)7
418,528
 
405,242
 
405,242
 
 
 
5

 
    2004  3   2005    
2005
4
                   
AMOUNTS IN ACCORDANCE WITH U.S. GAAP1 
                 
 
  SEK    
SEK
   
USD
 
Operating income (loss)
 
19,010
   
16,051
   
2,022
 
                   
Net income (loss)
 
14,416
   
11,396
   
1,436
 
Basic net income  per share 5
 
34.44
   
28.12
   
3.54
 
Diluted net income per share 5
 
34.40
   
28.08
   
3.54
 
                   
                   
Shareholders’ equity
 
73,079
   
79,486
   
10,015
 
 
  2001  
2002
2 
2003  
AMOUNTS IN ACCORDANCE WITH U.S. GAAP1 for the years 2001-2003
 
             
  SEK   SEK   SEK  
Net sales
189,280
 
186,198
 
183,291
 
Operating income (loss)
(4,014)
 
 
(5,171)
 
 
5,275
 
             
Net income (loss)
 
(4,320)
 
 
(6,265)
 
 
3,979
 
             
Income (loss) from continuing operations
(4,320)
 
(6,265)
 
3,979
 
             
Basic net income (loss) per share 8
(10.23)
 
(14.94)
 
9.49
 
Diluted net income (loss) per share 8
(10.23)
 
(14.94)
 
9.48
 
Income per share from discontinued operations 8
-
 
-
 
-
 
Income (loss) per share from continuing operations 8
(10.23)
 
(14.94)
 
9.49
 
             
Total assets
258,426
 
232,126
  
232,180
 
             
Shareholders’ equity
81,291
 
71,182
 
74,790
 
Share capital
2,649
 
2,649
 
2,649
 
Weighted average number of shares. (in thousands)7
422,429
 
419,445
 
419,445
 
Cash dividends per share 6
8.00
 
8.00
 
8.00
 
 
1
The consolidated financial statements of Volvo are prepared in accordance with IFRS, from 2005 with the comparison year 2004 restated accordingly. IFRS differs in certain respects from generally accepted accounting principles in the United States (US GAAP). See Notes 1 and 37 to the consolidated financial statements.

2
Net income (loss) in 2002 in accordance with US GAAP included value adjustments amounting to SEK 9,683 million pertaining to Volvo’s shareholdings in Scania AB, Deutz AB and Henlys Group plc. If a security’s quoted market price has been below the carrying value for an extended period of time, US GAAP includes a presumption that the decline is other than temporary. Under such circumstances, US GAAP requires that a value adjustment must be recorded in net income with a corresponding credit to Other comprehensive income.

3
In 2004, operating income from continuing operations under IFRS included a write-down of shares in Henlys Group plc amounting to SEK 95 million and a positive revaluation of shares in Scania AB amounting to SEK 915 million. In accordance with US GAAP earlier recorded value adjustments have been reversed amounting to net, positive, SEK 5.157 million.

4
Translated for convenience at US$ 1 = SEK 7.937 the Noon Buying Rate on December 30, 2005. Such translations should not be construed as representations that the SEK amounts represent, or have been or could be converted into, United States dollars at that or any other rate.
 
6

 
5
Net income (loss) per share is calculated as net income divided by the weighted average number of shares outstanding during the year. The weighted average number of shares outstanding during 2005 was 405,242,037.

6
Cash dividends are those declared out of the unrestricted equity of the parent company as recommended by the Board of Directors and approved by the Annual General Meeting of Shareholders held in the spring of the following year. In addition to a cash dividend of SEK 8.00 per share, the Board of Directors in March, 2004, proposed the Annual General Meeting to approve a dividend of 2 shares in the wholly owned subsidiary Ainax AB for every 31 shares in AB Volvo. Ainax AB would at the date of the distribution hold 27,320,838 Series A shares in Scania AB and a working capital of SEK 100 million. At the Annual General Meeting of AB Volvo on April 16, 2004, the Board’s proposal was approved. Based upon the carrying value of the net assets at April 16, 2004, the dividend of shares in Ainax AB represents a value of approximately SEK 15.00 per Volvo share.

7
On January 2, 2001, the 13,860,494 Class A shares and 30,291, 594 Class B shares that were repurchased during 2000 were transferred to Renault S.A. as partial payment for the shares of Renault V.I. and Mack Trucks. Subsequently during the beginning of 2001, AB Volvo repurchased an additional 10% of its outstanding shares - 13,860,494 Class A shares and 30,291,594 Class B shares of which 5% - 6,930,247 Class A shares and 15,145,797 Class B shares were transferred to Renault S.A. as final payment for the shares of Renault V.I. and Mack Trucks. Following these transactions, 419,444,842 Volvo shares were outstanding at December 31, 2001, and the weighted average number of shares outstanding in 2001 was 422,429,364.

 
The weighted average number of shares outstanding during 2002 and 2003 was 419,444,842.

 
On June 17, 2004, the Board of AB Volvo decided to acquire, through purchase on the Stockholm Stock Exchange, a maximum of 22,076,045 Series A and/or B shares, not exceeding a total purchase amount of SEK 4,300 million. By year-end 2004, a total of 9,315,000 Volvo A and B shares were repurchased equivalent to SEK 2,532 million. The total number of shares held by Volvo as treasury stock at year-end was 31,391,043 or 7.1% of the registered shares whereof Series A shares 7,075,246 and Series B shares 24,315,797. The weighted average number of shares outstanding during 2004 was 418,528,773. During 2005, a total of 5,730,000 Volvo shares were repurchased.

 
Total share capital by year end 2004 amounted to SEK 2,649 million and was based on 441,520,885 registered shares. During 2005 share capital was reduced by SEK 95 million through cancellation without repayment of 3,084,619 Series A shares and 12,752,222 Series B shares. After reduction share capital amounts to SEK 2,554 million and is based on 425,684,044 registered shares. The total number of registered shares by year end 2005 amounted to 425,684,044. Volvo held 5% of the registered shares at year end 2005, 21,220,535 shares whereof Series A shares 4,145,627 and Series B shares 17,074,908. The total number of outstanding Volvo shares by year end 2005 amounted to 404,463,509 whereof Series A shares 131,374,699 and Series B shares 273,088,810. The average number of outstanding shares was 405,242,037 in 2005.

8
U.S. GAAP basic and diluted net income (loss) per share is calculated as net income (loss) determined in accordance with U.S. GAAP divided by the weighted average number of shares outstanding during the year. Diluting securities during the period have impacted the average numbers of shares with 11 thousand, 117 thousand, 494 thousand and 625 thousand, for the respective year 2002, 2003, 2004 and 2005.
 
Exchange Rates
 
Fluctuations in the exchange rate between the krona and the dollar will affect the dollar equivalent of the krona price of the B Shares traded on the Stockholm Stock Exchange and, as a result, should affect the price of the American Depositary Shares in the United States. Such fluctuations will also affect the dollar amounts received by holders of American Depositary Shares on conversion by the depositary of cash dividends paid in kronor on the B Shares represented by the American Depositary Shares.
 
Since a substantial portion of the Company’s sales are sales outside Sweden (93% in 2004 and 94% in 2005), earnings are materially affected by movements in the exchange rate between the krona and the currencies in which such sales are invoiced. See “ Item 5. Operating and Financial Review and Prospects - 5.A Operating Results - General Impact of Currency Fluctuations.”
 
The following table sets forth certain information with respect to the Noon Buying Rate for cable transfers in SEK as certified for customs purpose by the Federal Reserve Bank of New York for the years shown:
 
7

 
Year
 
 
Average1
 
 
High
 
 
Low
 
 
Period-End
 
 
2001
   
 
10.4328
   
 
11.0270
   
 
9.3250
   
 
10.4571
 
2002
   
 
9.6571
   
 
10.7290
   
 
8.6950
   
 
8.6950
 
2003
   
 
8.0351
   
 
8.7920
   
 
7.1950
   
 
7.1950
 
2004
   
 
7.3320
   
 
7.7725
   
 
6.5939
   
 
6.6687
 
2005
   
 
7.5170
   
 
8.2434
   
 
6.7312
   
 
7.9370
 
November 2005
   
 
-
   
 
8.2434
   
 
7.9749
   
-
 
December 2005
   
 
-
   
 
8.1162
   
 
7.8323
   
-
 
January 2006
   
 
-
   
 
7.8097
   
7.5385
   
 
-
 
 
February 2006
   
 
-
   
 
7.9656
   
7.6487
   
-
 
March 2006
   
 
-
   
7.9604
   
 
7.6491
   
-
 

April 2006
   
-
   
7.7580
   
7.3579
   
-
 
                           
_________
1
The average of the Noon Buying Rates on the last day of each month during the year.
 
The noon buying rate on May 10, 2006 was 7.2867.
 
Credit ratings
 
In October 2005 Moody's Investors Service assigned a global long term A3 rating (stable outlook) on AB Volvo (publ) and confirmed its global short term P-2 rating. The following rating agencies confirmed its credit ratings on AB Volvo (publ) in 2005; Standard & Poor's International Ratings confirmed its global short term A2 rating ; Dominion Bond Rating Services confirmed its short term R-1 (low) rating for Volvo’s short term borrowing in the Canadian market, and its unsolicited long term rating A (low) (stable outlook); Rating and Investment Information, Inc. confirmed its long-term rating to A+ in the Japanese market. Volvo Treasury AB is assigned a K-1 rating by Standard & Poor's for short-term borrowing in Sweden. Fitch Ratings confirmed its global unsolicited short term rating F2, and the unsolicited long term rating A- (stable outlook).
 
Inflation
 
The effects of inflation on the Group’s operations have not been significant in recent years.
 
 
Not applicable.

 
Not applicable.

 
The commercial vehicles industry is cyclical. Historically, the Volvo Group’s markets have undergone significant changes in demand as the general economic environment has fluctuated. Investments in infrastructure, major industrial projects, mine operations and housing construction all impact the Group’s operations, since its products are an important part of these activities. Economic trends in Europe and North America are particularly important for the Volvo Group, since a significant portion of the Group’s net sales are generated in these markets.
 
8

 
The cyclical demand for the Group’s products has, at times, restricted, and may in the future temporarily restrict, the ability of the Volvo Group to manufacture and deliver orders in a timely manner. A prolonged delay in the Group's ability to deliver ordered products on a timely basis at a time when its competitors are not experiencing the same difficulty could adversely affect the Group's market shares.
 
To cope with the peaks and troughs in our industries, we need to act appropriately in the various stages of the business cycle. This may involve adjusting production capacity and operating expenses. See “Item 5. Operating and Financial Review and Prospects ¾ 5.A. Operating Results.”
 
There can be no assurances as to the future performance of the commercial vehicles industry or the timing or severity of changes in economic conditions affecting the commercial vehicles industry.
 
Competition is intense among manufacturers of commercial vehicles and engines. Continued consolidation in the industry is expected to create fewer but stronger competitors. Volvo’s products face substantial competition from commercial vehicles and engines provided by these and other manufacturers, and such competition may have a significant impact on the prices Volvo receives for its products and on the Group’s future sales volume. Our major competitors are DaimlerChrysler, Paccar, Navistar, MAN, Scania, Fiat, Caterpillar, Komatsu, Cummins and Brunswick.
 
In recent years, new competitors have emerged in Asia, particularly in China. These new competitors are mainly active on their domestic markets, but are expected to also increase their presence in other parts of the world.
 
Our brands are well-known and strong in many parts of the world. For the Volvo Group, it is important that all brands in the Group are developed and supported. Strong brands together with an attractive product portfolio make it possible for Volvo to be competitive.
 
There can be no assurance that Volvo will be able to compete successfully in the future. See “Item 4. Information on the Company ¾ 4.B. Business Overview.”
 
Prices for commercial vehicles may change. The prices of commercial vehicles have, at times, changed considerably in certain markets over a short period. This volatility is caused by several factors - such as short-term variations in demand, shortages of certain component products, uncertainty regarding underlying economic conditions, changes in import regulations, excess inventory and increased competition. Overcapacity within the industry can occur if there is an economic downturn in the Group's major markets or worldwide, potentially leading to further increased price pressure.
 
The financial result of the business depends on our ability to quickly react to changes in demand and particularly to adapt production levels, to reduce production and operating expenses, as well as deliver new competitive products and services.
 
There can be no assurances that such price volatility will not continue or that price volatility will not begin in markets which to date have not experienced such volatility. Overcapacity within the industry will likely occur if there is an economic downturn in Volvo’s major markets or worldwide, leading, potentially, to further increased price pressure. Price volatility in certain markets could adversely affect the Group’s results of operations.
 
The Group’s operations are exposed to currency fluctuations. In 2004 and 2005, approximately 90% of Volvo’s sales were in countries other than Sweden. Changes in exchange rates have a direct impact on the Volvo Group’s income statement, balance sheet and cash flow, as well as an indirect impact on Volvo’s competitiveness, which over time affects the Group’s earnings. The Volvo Group’s income statement is affected primarily by the translation of revenues and expenditures in foreign currencies, while the balance sheet is affected primarily by the translation of the net assets of foreign subsidiaries into Swedish kronor. In addition, currency movements may affect Volvo’s pricing of products sold and materials purchased in foreign currencies as well as those of its competitors, which may be affected differently by such movements. Since Volvo has substantial manufacturing operations in Sweden and generates a substantial portion of its revenues in currencies other than the Swedish krona, Volvo’s earnings in Swedish kronor could be adversely affected by an appreciation of the Swedish krona against other currencies. There can be no assurances that exchange rate fluctuations will not adversely affect the Group’s results of operations, cash flow, financial condition or relative price competitiveness in the future.
 
9

 
The objective of Volvo’s management of currency risks is to minimize short-term negative impact on Volvo’s income and financial position. Volvo uses forward contracts and currency options to hedge the value of future payments in foreign currencies. As with all hedging instruments, there are risks associated with the use of foreign currency forward exchange contracts, as well as interest rate swap agreements. While providing protection from certain fluctuations in currency exchanges and interest rates, by utilizing such hedging instruments Volvo potentially foregoes benefits that might result from such fluctuations in currency exchange and interest rates. Volvo has entered into, and expects to continue to enter into, such hedging arrangements with counterparties that are carefully selected and approved primarily on the basis of general creditworthiness. However, any default by such counterparties might have an adverse effect on Volvo.
 
See “Item 18 - Financial Statements - Note 36”. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”
 
Volvo’s profitability is dependent upon the successful introduction of new products. The Volvo Group’s long-term profitability depends on the Company’s ability to successfully launch and market its new products. Product life cycles continue to shorten, putting increased focus on the success of the Group's product development. It is highly important to meet and exceed customer expectations to be competitive in established markets and to be able to expand into additional markets and/or product segments.
 
Many of our products take a long time to develop from initial idea to finished product. It is important to involve customers in the early stages of the development process, to ensure the success of new products and at the same time being at the forefront in the research and development of new technologies that are important to the development of efficient products.
 
As both Volvo and its competitors either have recently introduced or plan to introduce new products or updated versions of existing products, Volvo cannot predict the market shares its new products will achieve. An inability by Volvo to introduce new innovating products in a timely fashion or to meet customer demand would have an adverse effect on the Group’s results of operations.
 
Volvo relies on suppliers for the provision of certain raw materials and components. Volvo purchases raw materials, parts and components from numerous outside suppliers. A majority of the Group’s requirements for raw materials and supplies is filled by single-source suppliers. The effects of delivery interruptions vary depending on the item or component. Certain items are standard throughout the industry, whereas others are internally developed and require unique tools that are time-consuming to replace. A supplier’s inability to deliver could have negative consequences for production at certain Volvo Group manufacturing sites.
 
The Volvo Group’s costs for raw materials and components can vary significantly over a business cycle. Cost variations may be caused by changes in world market prices for raw materials or by an inability of our suppliers to deliver.
 
The companies in the Volvo Group and their suppliers work closely together to manage material flows by monitoring suppliers’ financial stability, quality systems and production flexibility. However, there can be no assurances that it will not experience problems in the future. Unanticipated increases in the prices of raw material or components could also adversely affect the financial results of Volvo’s business.
 
The commercial vehicles industry is subject to extensive government regulation. Regulations regarding exhaust emission levels, noise, safety and levels of pollutants from production plants are extensive within the industry. These regulations are subject to change, often making them more restrictive. The costs to comply with these regulations can be significant for the automotive industry.
 
Most of the regulatory challenges regarding products relate to reduced engine emissions. The Volvo Group is a large player in the commercial vehicle industry and the world’s largest producer of heavy-duty diesel engines. The product development capacity within the Volvo Group is well consolidated to be able to focus resources for research and development to meet tougher emission regulations. Future product regulations are well known (provided that they are not changed), and the product development strategy is well tuned to the introduction of new regulations. The new regulations regarding product emissions are stringent, but our current assessment is that they are manageable for the Volvo Group.
 
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Volvo has had production facilities in numerous countries worldwide for many years. A worldwide production standard for environmental performance has been introduced, enabling production plants to achieve best industry standard.
 
Volvo is reliant on the proper protection and maintenance of its intangible assets. The Volvo Group’s products are primarily sold under the brand names "Volvo", "Volvo Penta", "Volvo Aero", "Renault", "Mack", "Prévost" and "Nova Bus". AB Volvo owns or otherwise has rights to a number of patents and brands that refer to the products the Company manufactures. These patents and brands, acquired over a number of years, have been valuable as the Volvo Group’s operations expanded. We do not consider that any of the Group’s operations are heavily dependent on any single patent or group of patents. However, an inability to protect intellectual property would have an adverse effect on Group operations.
 
Through Volvo Trademark Holding AB, AB Volvo and the Volvo Car Corporation jointly own the brand ”Volvo”. AB Volvo has the exclusive right to use the Volvo name and trademark for its products and services. Similarly, the Volvo Car Corporation has the exclusive right to use the mark for its products and services. To protect these rights and avoid any weakening of the brand, AB Volvo and the Volvo Car Corporation jointly introduced a control function governing the use of the brand name, to prevent others from taking unfair advantage of it.
 
Similar control functions apply to the use of the "Mack" brand name, which is owned by AB Volvo. The Volvo Group’s rights to use the Renault brand are restricted to the truck industry only and are regulated by a license from Renault SA, which owns the "Renault" brand.
 
See “Item 4.B - Business Overview - Patents, Trademarks and Licenses”.
 
Complaints or litigation from customers and other third parties could adversely affect Volvo. The Volvo Group could be the target of complaints and legal actions initiated by customers, employees and other third parties alleging health, environmental, safety or business-related issues, or failure to comply with applicable legislation and regulations. Even if such disputes were to be resolved successfully, without having adverse financial consequences, they could negatively impact the Group’s reputation and divert financial and management resources that could be used for other purposes.
 
Volvo’s Financial Services business area conducts business under highly competitive conditions in an industry with inherent risks. Financing for users of Volvo’s products is available through a variety of competitive sources, principally commercial banks and finance and leasing companies. Volvo Financial Services emphasizes prompt and responsive service to meet customer requirements and offers various financing plans designed to increase the opportunity for sales of its products and to generate financing income for the Group. The financial services offered involve risks relating to residual value, credit risk and cost of capital. Competition for customers and/or these risks may affect the Group’s results of operations in the future.
 
Other factors. Volvo continuously reviews its manufacturing and administrative processes with the aim of ensuring that Volvo products and operations meet applicable legal and other regulatory requirements. Volvo does also have insurance coverage in certain areas, for example product liability, business interruption and property.
 
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AB Volvo is an international transport equipment group with a worldwide marketing organization and production. AB Volvo, which was incorporated in 1915 under the laws of Sweden, started production of cars in 1927 and of trucks in 1928. Historically Volvo has operated in two main areas: cars and vehicles for commercial use. The latter includes trucks, buses, construction equipment and marine and industrial engines. Operations also include production and maintenance of aircraft engines and financial services. In March 1999, Volvo sold Volvo Cars to Ford Motor Company. As a result of this sale, Volvo is today focused entirely on the commercial transport products segment. Through the acquisition of Mack Trucks Inc. and Renault V.I. in 2001, the Volvo Group strengthened its position as a producer of heavy trucks.
 
Headquartered in Göteborg, Sweden, the Volvo Group had 81,856 employees at December 31, 2005. With 46% of sales in Western Europe, 5% in Eastern Europe, 29% in North America, 5% in South America and 10% in Asia, the Group operates in an international environment with production and assembly carried out on six continents. Its shares are traded on the Stockholm Stock Exchange in Sweden and in the United States its American Depositary Shares are traded on the Nasdaq National Market (“NASDAQ”).
 
Volvo’s brand name is strongly identified with quality, safety and concern for the environment. The Group’s position in the fields of vehicle safety and quality is being consolidated through continuing improvements and technical innovations. In the environmental area, Volvo is intensifying its efforts to reduce the negative impact on the environment throughout the entire life cycle of its products.
 
AB Volvo is domiciled in Göteborg, Sweden. The address and telephone number of AB Volvo is S-405 08, Göteborg, Sweden, +46 31 660000.
 
Significant events in 2005
 
Volvo Trucks launched new flagship in North America. In February, Volvo Trucks unveiled its new flagship for the North American market, the Volvo VT 880. The new truck is aimed at the prestige segment and is equipped with the new 16-liter engine, which was previously launched in Europe. The 16-liter engine incorporates advanced emissions controls and is designed to be able to meet emissions standards that will go into effect in 2007 and 2010. Towards the end of the year, the engine was also launched for the Volvo VN models.
 
Volvo Trucks launched its cleanest and most fuel-efficient trucks ever. In September, Volvo launched a new generation of trucks, the Volvo FH and Volvo FM. They are powered by an entirely new 13-liter engine and an improved 9-liter engine with SCR (Selective Catalytic Reduction) technology that meets forthcoming European exhaust emissions requirements.
 
With the launch of the new Volvo FH and Volvo FM models, Volvo Trucks takes a large step forward with regard to technology and environmental care. The all-new 13-liter engine has more power and better driveability than its predecessor and is available with power outputs of up to 520 hp. Compared with the current 12-liter engine, its fuel consumption is reduced by up to 5%. At the same time, the 9-liter engine has been upgraded and is now more powerful, offering better driveability. Both engines also meet the new emissions requirements that come into force in 2006 and, once the engines' software is updated, also the requirements that become effective in 2009 (Euro 5). The new truck models went into production in Gothenburg, Sweden, and Ghent, Belgium, towards the end of the year.
 
New Renault Magnum. Renault Trucks launched a new generation of its Renault Magnum tractor for long haulage at the beginning of 2005. Roll-out of the new generation is an example of the product renewal under way at Renault Trucks. The new generation features a new chassis and is equipped with a new engine, the DXI 12, and gearboxes such as the automated Optidriver II.
 
New Renault Premium Route. In September, Renault Trucks introduced a new generation of its truck model for national transportation, Renault Premium Route. Among other improvements, the new generation features a new driveline and chassis.
 
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It is equipped with a new 11-liter engine in power classes up to 440 hp and is designed for a wide range of transport needs. The new 11-liter engine is more efficient and, compared with the earlier engine, delivers up to 5% fuel savings. Other new features include an automatic Optidriver II transmission, an improved cab and a new front-end design. The first deliveries of the new Renault Premium occurred in October 2005.
 
New products from Mack Trucks. In October, Mack Trucks introduced a new range of trucks and heavy-duty diesel engines scheduled for launch in 2006. The new Mack Pinnacle is aimed at Mack Truck’s core customers for local and regional hauling, while the upgraded Mack Granite series reinforces Mack Truck’s leading position in the segment for construction vehicles in North America. First to be introduced from the new MackPower (MP) engine line is the 11-liter MP7, which features the new base architecture necessary to meet EPA 2007 emissions standards. Mack Trucks also plans to launch a 13-liter version of the engine, the MP8, in 2007.
 
First order for Volvo's new gas bus. Volvo Buses is one of Europe's leading manufacturers of gas buses with more than 1,000 gas-powered vehicles delivered since 1992. During 2005, the company advanced to the next phase with the launch of its new 9-liter gas engine for natural gas or biogas. The new 9-liter engine outperforms its predecessor and maintains emission levels below both Euro 5 and EEV, the European Union's special environmental class for environmentally adapted vehicles.
 
In September, Volvo Buses received its first order for the new Volvo 7700 with a gas engine. The local transit company in Bern, Switzerland placed an order for 32 articulated buses, with an option for 39 more.
 
Volvo Buses closed plant in Heilbronn, Germany. Volvo Buses manufactured one of its coach models, the Volvo 9900, a unique low-volume product, at its Heilbronn plant. The financial results for the Volvo 9900 had been unsatisfactory for many years. The decision to close this plant is in line with Volvo Buses' long-term strategy for achieving profitability and continuing to upgrade its global coach range and concentrate manufacturing at its main plants. Costs related to the closure, approximately SEK 95 M, were charged against second quarter earnings in 2005.
 
Volvo Buses received order for 2,000 city buses in China. In December it was announced that Volvo Buses received its largest order to date in China. Shanghai’s largest transit company Shanghai Ba-Shi (Group) Industrial Co. Ltd., ordered 2,000 Volvo B6R, a new 10.5-meter city bus. The bus has a high portion of locally purchased components and, consequently, complies with the Chinese Automotive Policy established in April 2005. Some 1,000 buses will be delivered through to summer 2006 and the remaining 1,000 through summer 2007. The chassis will be provided as package modules from Volvo Buses’ plant in Borås, Sweden. They will be assembled at the Sunwin bus plant in Shanghai, where the bodies are also being manufactured.
 
Volvo CE launched new series of motor graders. In November, Volvo Construction equipment launched an entire new series of motor graders, G900. The series comprises two platforms totaling seven models from 15 to 21 tons. The two smaller models are equipped with the 7.2-liter Volvo D7 engine, while the larger graders have the 9.4-liter engine, Volvo D9. The engines feature the new technology, VAC-T (Volvo Advanced Combustion Technology), which gives low emissions corresponding to standards in accordance with EU Stage IIIA and US Tier 3.
 
Volvo Aero signed major contracts. It was announced in December that Volvo Aero in Trollhättan, Sweden, will produce parts of the world’s largest aircraft engine, GE90-115B, which is on the Boeing 777-200LR and 777-300ER. In accordance with a new agreement with General Electric, Volvo Aero will manufacture components to the GE90-115B for an estimated order value of about SEK 2 billion during the next ten years. Volvo Aero will start production of several components of the engine in 2006.
 
AB Volvo sold Celero Support service company. AB Volvo announced in October, 2005 that it would sell the Group's service company Celero Support AB to Coor Service Management for SEK 680 M less the company’s net debt. The sale resulted in a capital gain for Volvo of about SEK 430 M, which was recognized in the fourth quarter. Celero Support AB provides various office and workplace services as well as maintenance of industrial plants and properties. Celero Support AB had 1,100 employees, with sales of about SEK 1.4 billion.
 
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Write-down of holding in Blue Bird. During the fourth quarter of 2005, AB Volvo wrote down its shareholding in Peach County Holdings, Inc. by about SEK 550 M. As of December 31, 2005, Volvo held 42.5% of the US-based company, which in turn owns the American school bus manufacturer Blue Bird. Since its reorganization in the preceding year, Blue Bird has not performed well. Since Volvo decided not to be further involved in continued activities regarding the company’s funding needs and improved liquidity, a write-down was made. After the write-down, the value of Volvo’s shareholdings in Peach County Holdings, Inc. is zero. In January 2006, Peach County Holdings, Inc. entered into bankruptcy proceedings (Chapter 11) and as a consequence of Volvo choosing not to participate in the continued reorganization, Volvo’s shares in the company were cancelled.
 
Sale of properties resulted in gain of SEK 188 M. In February, Danafjord AB (the Volvo Group’s real estate company) sold some of its non-strategic properties in Torslanda and Kalmar which were valued at approximately SEK 515 M. The sale resulted in a capital gain of SEK 188 M for Volvo Financial Services, which manages Danafjord.
 
Tax rulings yielded Volvo nearly SEK 300 M. The Swedish Administrative Court of Appeal delivered rulings in several tax cases affecting various companies in the Volvo Group. Combined, the court rulings had a positive effect of nearly SEK 300 M on AB Volvo's second-quarter earnings. In all, 16 different rulings were delivered covering the tax-assessment years 1991-1999. All of the cases involved appeals of County Administrative Court rulings. To a large extent, the Court of Appeal’s verdicts followed previous rulings by the lower courts. The Court of Appeal did, however, overturn a lower court ruling and granted AB Volvo a tax deduction of SEK 1.5 billion on the sale of shares in Volvo Trucks North America to an American subsidiary in 1996. To a large extent, the Volvo Group had already made provisions for tax expenses based on the original rulings of the lower courts. Accordingly, the rulings of the Court of Appeal had a positive effect of nearly SEK 300 M on AB Volvo, including SEK 70 M in interest.
 
US Supreme Court supported Volvo Trucks in antitrust case. In January 2006, the US Supreme Court issued a ruling in favor of Volvo Trucks in a dispute with one of its dealers regarding competitive pricing practices. The US Supreme Court found that under US law there is no obligation to provide the same discounts to dealers in conjunction with them participating in different negotiations. Volvo’s position in the case, which has broad implications beyond the heavy-truck industry, was supported by the US Department of Justice.
 
Share buyback completed. March 1, 2005 marked the completion of the share repurchase program, authorization for which the Board received at the Annual General Meeting on April 16, 2004. The goal of the repurchase program was to optimize AB Volvo’s capital structure. A total of 300,000 Series A shares and 14,475,000 Series B shares were repurchased, corresponding to SEK 4,295 M. Following the repurchase, AB Volvo held a total of 7,230,246 Series A shares and 29,890,797 Series B shares, corresponding to approximately 8.4% of the total number of shares in the company. Post the below described cancellation AB Volvo owns 5% of its own shares.
 
Cancellation of shares and new repurchase mandate. The Annual General Meeting resolved that the Company’s share capital be reduced by SEK 95,021,046 through cancellation without repayment of 3,084,619 Series A shares and 12,752,222 Series B shares that the company repurchased. The cancellation was implemented during the second quarter of 2005. After the cancellation, AB Volvo owns 5% of its own shares. The Annual General Meeting also resolved to authorize the Board of Directors of AB Volvo to decide on the purchase and transfer of the company’s own shares. After the decision no further purchases of own shares were made during the remainder of 2005.
 
Allotment of shares in incentive program. Senior executives in the Volvo Group were allotted 63,667 Series B Volvo shares under the framework of the incentive program approved at the 2004 Annual General Meeting. Shares were allotted based on the degree of fulfillment of certain financial goals for fiscal year 2004, as established by the Board.
 
New share based incentive program. During the Annual General Meeting it was decided to implement a new, share-based incentive program during the second quarter of 2005 for senior executives at the Volvo Group. The program stipulated that a maximum of 185,000 Series B shares in the Company could be allotted to a maximum of 165 senior executives (including members of Group Management), during the first six months of 2006.
 
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Significant events in 2006
 
New Volvo FH16. In the beginning of February 2006, Volvo Trucks launched a new Volvo FH16 with a Volvo D16E engine rated at 660 hp. As the result of a newly developed engine brake, braking power was increased by 15%. The strong driveline features Volvo’s I-Shift gearbox system dimensioned to handle trailer weights of 60 tons or more.
 
Volvo became major shareholder in Nissan Diesel. On March 21, 2006 AB Volvo acquired 40 million common shares, corresponding to 13% of the common shares, in the Japanese truck manufacturer Nissan Diesel from Nissan Motor Co. Ltd, (“Nissan Motor”) with an option to acquire the remaining 6% of the common shares in Nissan Diesel, owned by Nissan Motor, from Nissan Motor within four years. The purchase price is approximately SEK 1.5 billion for the 13% stake acquired.
 
The transaction is believed to strengthen the Volvo Group's Asian strategy and could provide the Group with a stronger dealer and service network in Japan and Southeast Asia, and create a possibility for further industrial cooperation with Nissan Diesel in such areas as engines and transmissions.
 
Renault Trucks signed agreement in principle with Nissan Motor concerning new light truck. In February, AB Volvo's subsidiary Renault Trucks entered into an agreement in principle with Nissan Motor Co., Ltd concerning the sales and marketing of a new light truck. The new truck, which will be manufactured by Nissan and sold under the Renault name, will supplement Renault Trucks' existing offer of light trucks, Renault Master and Renault Mascott.
 
In accordance with the agreement, the new truck will be sold via Renault Trucks' dealers, and deliveries are scheduled to commence during the first half of 2007. The new truck will be based on the same platform as that to be used for the next generation Nissan Cabstar and Atlas.
 
Volvo Group premiered hybrid technology for heavy vehicles. In March 2006 Volvo Group presented a new, efficient hybrid solution for heavy vehicles. The Volvo Group’s hybrid concept provides maximum fuel-saving effects on routes with frequent braking and accelerations, for example, city bus traffic, city distribution, refuse collection and construction work. Based on calculations, fuel savings can amount to 35% in these applications.
 
Volvo Trucks launched new models for the North American market. In March, Volvo Trucks announced a broadening of its product program on the North American truck market with the launch of two models with new cab variants for the prestige segment, the Volvo VT830 and Volvo VN730. Both models are intended primarily for owner operators. The newly launched cab models offer the same interior roominess, and the lower roof provides better aerodynamics and correspondingly improved fuel economy for rigs with low trailers, such as tankers.
 
Volvo Aero signed major contracts. Volvo Aero reported in January 2006 that it had signed a contract covering production of the largest component in an aircraft engine, the fan case, for the Rolls-Royce Trent 1000 engine. The engine will be mounted on Boeing’s new aircraft, the 787 Dreamliner. The fan case will be produced in titanium and have a diameter of three meters. The sales value of the contract is estimated at SEK 1.1 billion during a period of 15-20 years.
 
It was also announced in January 2006, that Volvo Aero and General Electric have agreed that Volvo Aero will increase its part of GE’s new engine, GEnx. Volvo Aero will manufacture additional components for the engine. The new agreement is expected to generate sales of SEK 6 billion over a 30-year period.
 
Annual General Meeting of AB Volvo. At the Annual General Meeting of AB Volvo held on April 5, 2006, the Board's proposal to pay a dividend to the shareholders of SEK 16.75 per share, a total of about SEK 6,775 million, was approved.
 
Per-Olof Eriksson, Tom Hedelius, Leif Johansson, Louis Schweitzer and Finn Johnsson were re-elected members of the Board of AB Volvo and Ying Yeh, Philippe Klein and Peter Bijur were newly elected. Finn Johnsson was elected Board Chairman.
 
The Meeting resolved to establish a share-based incentive program during the second quarter of 2006 for senior executives in the Volvo Group. The program mainly involves that a maximum of 518,000 Series B shares in the Company could be allotted to a maximum of 240 senior executives, including members of the Group Executive Committee, during the first six months of 2007. The allotment shall depend on the degree of fulfillment of certain financial goals for the 2006 fiscal year, which have been set by the Board. If these goals are fulfilled in their entirety and if the price of the Volvo B share at the time of allotment is SEK 370, the costs for the program will amount to about SEK 230 million. So that Volvo shall be able to meet its commitment in accordance with the program in a cost-efficient manner, the Meeting further resolved that Volvo may transfer own shares (treasury stock) to the participants in the program.
 
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Capital Expenditures
 
The following table sets forth the Group’s aggregate capital expenditures for property, plant and equipment, intangible assets and assets under operating leases, by principal business areas for each of the two years ended December 31:
 
   
2004
 
2005
 
Capital Expenditures  
 (In millions of SEK) 
 
Trucks
   
5,030
   
7,190
 
Buses
   
176
   
250
 
Construction Equipment
   
1,158
   
906
 
Volvo Penta
   
297
   
243
 
Volvo Aero
   
801
   
904
 
Financial Services
   
4,784
   
386
 
Other and corporate capital expenditures
   
237
   
4,972
 
Group total
   
12,483
   
14,851
 
 
Investment projects were principally for plant and machinery for the production, design and development of commercial vehicles and machinery. The following table illustrates the geographic distribution of the capital expenditures:
 
   
2004
 
2005
 
   
 (In millions of SEK) 
 
Sweden
   
3,690
   
5,935
 
Europe (excluding Sweden)
   
6,305
   
5,770
 
North America
   
1,835
   
2,451
 
Other countries
   
653
   
695
 
Group total
   
12,483
   
14,851
 

Capital expenditures for property, plant and equipment in 2005, amounted to SEK 6.8 billion (SEK 5.8 billion). Capital expenditures in Trucks, which amounted to SEK 4.5 billion (SEK 3.5 billion), were made to improve efficiency in the European industrial system, increase the number of service workshops for the dealer network in Europe, continued modification of the Hagerstown plant in North America for manufacturing of engines and transmissions and for a changeover for production of a new 13-litres engine in Skövde, Sweden, and a new 11-liter engine in Vénissieux. Capital expenditures decreased in Construction Equipment from SEK 1.0 billion to SEK 0.8 billion, mainly for development of production plants and in tools and equipment for new products. In Volvo Aero the level of capital expenditures increased from 0.2 billion to SEK 0.3 billion. Investments remained at the same level as last year in Buses at SEK 0.1 billion and decreased in Volvo Penta from SEK 0.2 billion to SEK 0.1 billion. Approved future capital expenditures amounting to SEK 7.8 billion (SEK 8.2 billion) relate mainly to investments for the next generation of trucks and engines. A major part of the investments relate to entrance fees to become a partner in the new GEnx engine and in the LM2500 industrial gas turbines, according to agreements with General Electric.
 
Capital expenditures for intangible assets, mainly product and software development, amounted to SEK 3.5 billion (SEK 2.3 billion). The capital expenditures were distributed among Trucks SEK 2.4 billion (SEK 1.2 billion), Buses SEK 0.1 billion (SEK 0.1 billion,), Construction Equipment SEK 0.2 billion (SEK 0.1 billion) and Volvo Penta SEK 0.1 billion (SEK 0.1 billion) and Volvo Aero SEK 0.6 billion (SEK 0.6 billion). A major part of the investments in Volvo Aero relate to entrance fees to become a partner in the new GEnx engine and in the LM2500 industrial gas turbines, according to agreements with General Electric.
 
 
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Capital expenditures for assets under operating leases amounted to SEK 4.5 billion (SEK 4.4 billion). The capital expenditures pertained mainly to vehicles and machines subject to new operating lease contracts with external customers within Financial Services’ operations in North America and Western Europe.
 
Capital expenditures currently in progress are shown in “Item 5.B - Liquidity and Capital Resources”.

 
General
 
Seven years ago, the operations of the Volvo Group were concentrated on those products with the strongest positions and most competitive volumes. This meant that Volvo exited the car industry and transferred these resources over to commercial vehicles, machines and engines through a series of acquisitions.
 
In recent years, major changes have been implemented in the organization to coordinate the new structure and simultaneously renew large segments of the product range. The result is a streamlined Group with considerably reduced costs and strong global market positions.
 
Three large acquisitions were made on three different continents: Samsung’s excavator operations in Southeast Asia, Renault Trucks in Europe and Mack Trucks Inc. in North America. These acquisitions strengthened the Group’s presence in Asia and made the Volvo Group the largest heavy truck manufacturer in Europe, with a market share of 25.2 percent, and among the largest in North America, with a 19.6 percent market share by the end of 2005. Following the acquisitions, Volvo believes it is the world’s largest manufacturer of diesel engines, in the 9-16 liter segment, for heavy vehicles and machinery.
 
All business areas hold strong positions in their respective markets. Volvo Buses is one of the world’s largest bus manufacturers and Volvo Construction Equipment (“Volvo CE”) is one of the largest manufacturers of construction equipment. Volvo Penta is a global market leader in marine leisure diesel engines. Components from Volvo Aero are included in 80 percent of all new major aircraft in the world.
 
Strong growth in all major markets
 
Demand for the Volvo Group’s products is increasing due to the general economic development with rising trade among the various regions of the world, growing transportation needs and an increasing need to build new infrastructure.
 
The Volvo Group is active in an industry that is cyclical with an underlying growth rate in mature markets of about 4% over a business cycle. In growth regions, such as Asia and Eastern Europe, the rate of increase is considerably higher.
 
Increasingly stringent environmental requirements are a factor that has contributed to rising costs for product development and manufacturing. One of the main reasons is that substantial investments are required to conduct research and development into new technologies to reduce emissions from vehicles and into supplementary fuels and alternative drivelines. To ensure that these costs are spread among larger volumes, a consolidation process is under way among manufacturers through mergers and acquisitions.
 
In mature markets in the US and Europe, the truck industry has been consolidating for several decades and has made considerable progress, also with several intercontinental acquisitions. In other areas, such as the construction equipment sector, the pressure for consolidation is expected to increase.
 
At the same time, in growth markets, new competitors have grown into significant regional players. This structural transformation is creating opportunities for the Volvo Group, which has a strong financial position.
 
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The Volvo Group occupies an established position in European and North American markets, which are showing relatively firm underlying growth. However, the fastest growth rates are noted in parts of the world where the Group had very insignificant operations just 10-15 years ago. In these markets, such as Asia, the Volvo Group intends to grow.
 
China and India are examples of markets that have already reached a considerable size and in the future will become even more important for the Volvo Group’s development. The market in Eastern Europe is also growing strongly and the Group is well positioned to capitalize on the market trend.
 
Sales by Geographical Areas
 
The following table sets forth the geographic distribution of the Volvo Group’s net sales. Sales are shown based upon the market where the customer is located.
 
   
2004
 
2005
 
 Market area:  
 (in millions of SEK) 
 
    Western Europe
   
108,015
   
112,037
 
    Eastern Europe
   
11,062
   
11,986
 
    North America
   
54,769
   
69,743
 
    South America
   
7,338
   
12,479
 
    Asia
   
20,789
   
22,699
 
    Other markets
   
9,103
   
11,615
 
Total
   
211,076
   
240,559
 
 
Strategy
 
The Volvo Group focuses its business on products for commercial use. The Group’s business areas have competitive volumes and strong global positions. The objective is to be number 1 or 2 in terms of size in the sectors in which we are active, or to show a superior growth rate. An important element of this strategy is to strengthen positions on markets with high growth potential and to increase the customer base.
 
Customer oriented strategy. The ability to attract various categories of customers is one of our most valuable assets. Our brands are well-known and strong in most parts of the world. Strong brands combined with an attractive product portfolio enable the Group to stay competitive. Currently, we are working intensively with developing our dealer networks and as a result improving service to our customers.
 
Strong product portfolio. The Volvo Group’s large volumes provide resources to aggressively develop customized customer offerings optimized for various applications. Concurrently, this provides the Group the possibility to invest in future technologies such as alternative drivelines and supplementary fuels. In recent years, the rate of product renewal has increased significantly within all of the business areas and 2005 was another year with major product launches. By capitalizing on economies of scale and Group-wide technologies and architecture, the Volvo Group will further strengthen its product portfolio in the years ahead and thus increase its competitiveness.
 
Capitalize on economics of scale. The Group’s size and structure creates opportunities for effectively utilizing Volvo’s collective resources and achieving economies of scale in a number of key areas. The development and manufacturing of engines have been concentrated in a separate business unit, Volvo Powertrain, which provides the Group with engines and other driveline components. There is also Volvo Parts, which optimizes inventory management and distribution of spare parts, and Volvo Logistics, which handles optimal logistics solutions for the Group’s materials flow.
 
Reduce costs. With the aim of reducing the costs of developing and manufacturing products, the Group establishes systems and structures for the transfer of technologies and best practices. Common production methods and internal processes are increasingly being used, which creates flexibility and efficiency. In addition, larger volumes make the Volvo Group an attractive business partner, which increases the possibilities of attracting the best suppliers.
 
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We’re working on increasing the degree of shared components and utilizing shared modules. For example, Volvo Powertrain has developed two Group-wide engine platforms that gradually will replace the previous 18 engine platforms. This will be occurring concurrently with the introduction of new products in the coming years. We are engaged in increasing numbers of Group-wide development projects often in cooperation with selected suppliers.
 
Flexibility. An important task in the internal efficiency enhancement work is to achieve a more rapid adjustment to fluctuations in the economy. This involves both the ability to increase production and sales in upturns and to reduce them in economic downturns. This trend also requires increased flexibility among suppliers.
 
Capital rationalization. Since 2001, working capital has been significantly improved, mainly through a reduction in inventories and accounts receivable. In combination with the increased profitability, the capital that has been released has created a strong cash flow, which has enabled the Volvo Group to engage in product renewal throughout the entire business cycle. In the coming years work in this area will focus on using sales and administrative resources more efficiently.
 
Summary of Group Businesses
 
Volvo Trucks. Volvo began manufacturing trucks in 1928 and specializes in heavy trucks, with gross vehicle weight above 16 tons. Volvo Trucks products are marketed in more than 130 countries. The greater part of the sales takes place in Europe, North and South America and Asia.
 
Renault Trucks. Renault Trucks traces its origin to the Berliet and Renault companies founded in 1895 and 1898. With a product program that ranges from light trucks for city distribution to heavy long-haul trucks and military vehicles, Renault Trucks is a true multispecialist with the ability to meet the specific requirements of all types of road transport. Renault Trucks has a strong presence in Europe with 1,350 dealers and service centers, which on a global basis extends to 2,000.
 
Mack Trucks. Mack Trucks is one of the largest manufacturers of heavy-duty trucks and major product components in North America. Since its founding in 1900, Mack has built on its reputation of strength and durability to become one of the leading heavy-duty truck brands in the North American market. In the US, Mack is a leader in the vocational segments of the heavy-duty truck market. A clear majority of Mack vehicles employ drivelines manufactured in-house - a unique feature in the North American truck industry. In addition, Mack trucks are sold and serviced in more than 45 countries.
 
Buses. Volvo Buses has a broad range of modern buses that offer efficient transport solutions. The product offering includes complete buses and chassis for city and intercity traffic as well as coaches.
 
Construction Equipment. Volvo CE’s products, spare parts and services are offered worldwide in more than 125 markets. Customers are using the products in a number of different applications including general construction, road construction and maintenance, forestry, demolition, waste handling, material handling and extraction.
 
Volvo Penta. Volvo Penta offers complete power systems and service for leisure boats, workboats and industrial applications such as power-generating equipment. Volvo Penta operates within three areas of activity: Marine Leisure, Marine Commercial and Industrial.
 
Volvo Aero. Volvo Aero offers a wide range of services and products for the commercial, aerospace and military aircraft industries, including high-technology components for engines, sale of parts for engines and aircrafts and overhaul and repair of aircraft engines and gas turbine engines. In addition, Volvo Aero provides aftermarket services for gas turbine engines and systems.
 
Financial Services. Volvo Financial Services (VFS) provides services in four main areas: customer finance and insurance, treasury operations, real estate management and related services. These services enable Volvo to take a Group-wide approach to financial risk.
 
19

 
Trucks
 
The total market. Overall, demand was very high on the markets in Europe, North America and South America. The total market for heavy trucks in Europe 27 (EU member countries plus Norway and Switzerland) rose 9% to 276,700 trucks in 2005, which is a new record level. Registration in the UK increased by 5%, in France by 21%, while the market in Germany was up 4% and in Spain by 10%.
 
The market for heavy trucks in North America (Class 8) rose 29% in 2005 to 328,900 heavy trucks, compared with 255,500 trucks in 2004. This was driven by the continued strong US economy, with rising transport needs. In addition, demand was driven by a need to renew truck fleets and that some customers wanted to purchase new trucks prior to the new, stricter emissions legislation becoming effective on January 1, 2007.
 
The market for heavy trucks in Brazil declined by 9%.
 
Business environment. As a result of the strong demand in Europe and North America, the capacity utilization of truck manufacturers overall was high during the year. However, the investments in increased capacity were limited, due in part to supplier difficulties in meeting the already high pace of production for new trucks.
 
Instead of investing in increased production, truck manufacturers focused on raising capacity utilization in existing plants through various forms of efficiency enhancement measures and by aligning prices to the prevailing market demand.
 
The sharp price hikes on certain raw materials, mainly steel, receded during the year. The business area succeeded in offsetting the higher raw material costs through increased efficiency and active pricing.
 
In 2005, Trucks accounted for 67% of Volvo’s sales.
 
Volvo Trucks. Volvo Trucks has developed into one of the world’s largest producers of heavy trucks with a total weight exceeding 16 tons. Volvo Trucks’ products are marketed in more than 130 countries. The trucks are used for a wide range of applications, from distribution in congested city traffic to heavy-duty construction in desert heat or timber transport in remote forestlands.
 
Volvo Trucks’ competitive product range was strengthened further in 2005. At the beginning of the year, Volvo Trucks launched the Volvo VT 880 flagship with a 16-liter Volvo engine in the North American market. Later in the year, the 16-liter engine was also offered in the Volvo VN models in North America and in April, the first D12 engine manufactured in the US was delivered.
 
During the autumn, Volvo Trucks rolled out the new Volvo FH and Volvo FM models with the new 13- and 9-liter engines. The engines comply with the forthcoming Euro 4 and Euro 5 emission standards and improvements include a reduction in fuel consumption of up to 5%. Moreover, a new generation of Volvo VM was launched in Brazil and the product line was expanded with a three-axle model that handles a total weight of 26 tons.
 
During 2005, Volvo Trucks delivered 103,696 trucks, an increase of 7% compared with a year earlier. Deliveries rose 23% in North America and 2% in Asia (which includes deliveries in Iran of 14,980 trucks in 2005 and 14,253 trucks in 2004). Deliveries in Europe decreased by 1%.
 
During the year, Volvo Trucks continued to strengthen its dealer network in Europe, including the inauguration of the first wholly owned service facility in Russia, outside St. Petersburg.
 
Renault Trucks. With a product range stretching from light commercial vehicles for city distribution to heavy trucks for long-distance transport, Renault Trucks is equipped to meet the demands placed on various types of highway transportation. Renault Trucks has a strong market presence, with 1,350 dealerships and service locations in Europe and 650 in the rest of the world.
 
The total renewal of the product range, which began at the end of 2003 and continued through 2004, was completed in 2005 with the new Renault Magnum and Renault Premium Route. The new Renault Magnum, intended for long haulage, was introduced in February 2005. It features a new chassis, new engine and gearbox and extensive improvements in driver comfort. In addition, fuel consumption was reduced considerably. A new version of the Renault Premium, a truck for national haulage, was introduced in September. Among other features, the new version offers an improved driver cab, new driveline and chassis as well as being equipped with a more powerful and fuel-efficient engine. In October, a new version of Renault Magnum was shown. It is fitted with a new 13-liter engine, developing 500hp and meeting the Euro4/5 with SCR-technology.
 
20

 
Deliveries by Renault Trucks amounted to 74,461 vehicles, which was 6% more than a year earlier. Deliveries in Europe rose 3% to 60,988 trucks, while deliveries in the rest of the world increased by 22% to 13,473.
 
Mack Trucks. Mack Trucks is one of the leading producers of heavy-duty trucks in North America. Since its founding, Mack Trucks has focused on power and reliability, which has contributed to making the company one of the strongest heavy-duty truck brands in the North American market. In the US, Mack Trucks is the predominantly leading producer of trucks in the construction, economic haul and refuse segments. In total, Mack Trucks has sales and service in more than 45 countries.
 
Mack Trucks’ deliveries rose 42% to 36,222 trucks in 2005, compared with 25,469 trucks in the preceding year. The improved sales are the result of increased demand in Mack Trucks' core segments in North America.
 
The positive development of the American economy fueled a high pace of activity in the construction and transport industries, which consequently resulted in Mack Trucks posting historically high order bookings at the beginning of 2005. When the industry’s production capacity for 2005 reached its ceiling, customers became more cautious with ordering trucks for delivery in 2006. Demand slowed to more sustainable levels during the rest of the year, but remained highly favorable bolstered by the strong economy in the US.
 
In October, Mack Trucks took the largest step to date in the renewal of its product line with the launch of two model series, Mack Pinnacle and Mack Granite, and a new line of heavy-duty diesel engines.
 
The new trucks are based on the Advantage and Cornerstone chassis introduced in 2004 and early 2005, which means that Mack Trucks’ range in construction and highway transport will be completely renewed when Mack shifts to the new engine generation in the beginning of 2007.
 
The new engine series, Mack Power (MP), features many different engine alternatives and is the key in Mack Trucks’ solution to the new emission standards that become effective in January 2007. The first engine introduced is the 11-liter MP7, which meets current standards and will be sold in 2006. This will be followed by an upgraded version of the MP7 and a new 13-liter engine, MP8, which meet the emission standards that become effective in 2007.
 
Strategic development. The ambitions for 2006 are:

·  
Successful introductions and production change-overs.
 
·  
Introduce engines in all trucks that meet future emissions standards in Europe and the US.
 
·  
Maintain high pace of activity in the development of alternative drivelines.
 
·  
Further development of dealer network.
 
Products. The customer offering is based on an adequate vehicle specification for every customer's needs. The truck operations of the Volvo Group have a broad range of truck specifications for all kinds of transport needs, from city distribution to construction work and long-distance transports. More than 90 % of the trucks branded Volvo are sold in the heavy truck segment (above 16 tons), where all models are based on the company's shared technology and architecture.
 
Customers are also offered an extensive range of support services. For example, financial services include many different kinds of leasing solutions, often in combination with service and insurance agreements.
 
Production. The following table sets forth, by series, the number of trucks produced by Volvo during each of the years 2001 through 2005 and the numbers of trucks produced by Mack and Renault during the years 2001 through 2005.
 
21

 
Number of trucks produced
 
 
2001
 
 
2002
 
 
2003
 
 
2004
 
 
2005
 
Volvo FL -series
   
6,690
   
5,640
   
4,820
   
4,980
   
5,052
 
Volvo FL7, 10, and 12-series and
FM7, 10, and 12-series
   
14,580
   
15,300
   
17,480
   
18,900
   
20,102
 
Volvo FH-series
   
28,920
   
31,880
   
33,720
   
45,010
   
42,951
 
Volvo NL and NH-series
   
2,400
   
1,490
   
1,940
   
1,170
   
2,312
 
Volvo VN, VT series and VHD
   
12,860
   
14,300
   
17,080
   
25,640
   
32,256
 
Volvo VM
   
-
   
-
   
400
   
1,600
   
1,842
 
Total
   
65,450
   
68,610
   
75,440
   
97,300
   
104,515
 
Mack CH
   
7,298
   
7,540
   
1,744
   
2,006
   
3,786
 
Mack CL
   
984
   
288
   
64
   
170
   
364
 
Mack Vision
   
2,122
   
2,523
   
4,811
   
7,283
   
9,403
 
Mack Granite
   
1,099
   
4,592
   
6,217
   
10,935
   
16,568
 
Mack DM
   
703
   
528
   
458
   
519
   
365
 
Mack DMM
   
111
   
47
   
-
   
-
   
-
 
Mack LE
   
1,393
   
1,084
   
964
   
849
   
1,238
 
Mack MR
   
3,015
   
1,668
   
2,034
   
2,603
   
3,325
 
Mack RB
   
488
   
103
   
130
   
130
   
23
 
Mack RD
   
4,532
   
2,298
   
921
   
17
       
Mack RD8
   
86
   
35
   
54
   
4
       
Other
   
-
   
-
   
1,122
   
1,121
   
1,126
 
Total
   
21,831
   
20,706
   
18,519
   
25,637
   
36,198
 
Renault Kerax
   
7,967
   
7,677
   
6,674
   
7,063
   
8,800
 
Renault Midlum
   
12,764
   
12,545
   
12,801
   
16,018
   
15,484
 
Renault Premium
   
17,918
   
16,150
   
15,567
   
17,250
   
18,991
 
Renault Magnum
   
7,027
   
7,848
   
7,516
   
8,801
   
8,202
 
Total
   
45,676
   
44,220
   
42,558
   
49,132
   
51,477
 
Total Volvo, Mack and Renault
   
132,957
   
133,536
   
136,517
   
172,069
   
192,190
 

Production and capacity. Production of trucks in 2005 amounted to 104,515 Volvo Trucks (97,300), 51,477 Renault Trucks (49,132) and 36,198 Mack Trucks (25,637). In addition, Renault Trucks also distributes the Renault Mascott and Renault Master trucks, which are produced by Renault SAS and the SISU trucks.
 
Renault Trucks’ plant in Blainville, France opened a new, ultramodern facility for pretreatment of cabs for painting, with higher capacity, better quality and improved environmental features.
 
To meet the favorable demand for products in the construction segment, Mack Trucks started a second shift in May 2005 at the plant in Macungie, Pennsylvania, in the US, which increased production capacity by about 40%.
 
Investments to produce the engines of tomorrow for the North American market continued in Hagerstown, Maryland in the US. During the year, series production of Volvo’s 12- and 16-liter engines was started and pre-production of the new Mack engines series was initiated toward year-end.
 
22

 
Volvo Trucks opened a new assembly plant in Durban, South Africa, as a consequence of operations being discontinued at the plant in Botswana. AB Volvo decided during the year to invest SEK 650 M in a new paint shop at the Umeå cab plant in Sweden. The new facility is expected to be the world’s cleanest topcoat paint shop.
 
Markets and Sales. In 2005, Trucks accounted for 67% of Volvo’s sales. Volvo’s truck operations’ sales by principal geographic market area and operating income for the years 2004 and 2005 are set forth in the following table:
 
   
2004
 
2005
 
     
(In millions of SEK) 
 
Western Europe
   
68,664
   
70,567
 
Eastern Europe
   
8,767
   
9,139
 
North America
   
35,154
   
46,129
 
South America
   
5,223
   
7,657
 
Asia
   
12,378
   
13,551
 
Other markets
   
6,693
   
8,353
 
Total sales
   
136,879
   
155,396
 
Operating income
   
8,992
   
11,717
 

 
Total deliveries from the Group’s truck operations amounted to 214,379 trucks in 2005, an increase of 11% compared with 2004. In Europe, 103,622 trucks were delivered, compared with 102,666 trucks in 2004. Deliveries in North America were up 32% compared with 2004 and totaled 64,974 trucks. Deliveries in Asia continued to develop favorably. During 2005, 14,980 trucks were sold to Iran (14,253 in 2004). Towards the end of the year there was a significant decline in order intake and sales volumes.
 
Buses
 
The total market. The total bus market rose moderately or continued at a high level in most parts of the world during 2005. However, a slowdown was noted in Europe at the end of the year. Economic growth in Asia remained strong and bus sales continued to rise in many countries. Considerable price pressure continued in many markets.
 
General. As of December 31, 2005, Volvo was one of the largest manufacturers, by volume, of heavy buses, coaches and bus chassis (with a total weight above 12 tons) in the world. Volvo Buses' product line comprises complete buses, bus chassis and bodies for various applications such as city, intercity buses and coaches as well as related services. Priority is given to transport economy, reliability and environmental characteristics in the development of products of Volvo Buses. Buses’ customers are primarily bus operators with vehicle fleets varying from a single bus up to as many as 20,000 buses.
 
In 2005, Buses accounted for 7% of Volvo’s sales.
 
Business environment. The consolidation trend toward large bus operators continues. However, there is still potential for small companies in the coach segment. The large operators are expected to become stronger as they focus on reliability and life-cycle costs. They want to cooperate with few suppliers who can offer complete solutions: vehicles, financing, after-market and various forms of software solutions.
 
Regional authorities and large cities are placing heavy demands on bus safety and minimal environmental impact. There is also an increasing demand for vehicles that operate on alternative fuels.
 
The increasingly difficult traffic situation in many large cities has led to a growing interest in Bus Rapid Transit (BRT) systems, which allows buses to travel in separate bus lanes. The buses are modern articulated buses with a high capacity and the bus stops are adapted for rapid boarding and exiting. Volvo Buses is the leading supplier of buses within BRT.
 
Strategic development. Volvo Buses' ambition for 2006 is to:
 
23

 
 
·  
Continue the implementation of the earnings-improvement program within Volvo.
 
·  
A reduction in product costs through such measures as increased standardization and enhancement of the production process.
 
·  
Renewal of the engine program to meet the requirements of Euro 4 and Euro 5.
 
·  
Improved customer service through expanded cooperation with dealers and service centers.
 
Products. Volvo Buses has a broad range of modern buses that offer efficient transport solutions. The product offering includes complete buses and chassis for city and intercity traffic, as well as coaches.
 
In 2005, a low-floor version of the Volvo B9S was launched, both as an articulated bus and a bi-articulated bus. The chassis is highly suited for modern mass transit systems, so-called Bus Rapid Transit (BRT), featuring quick and comfortable entering and exiting for passengers. The new chassis was delivered as an articulated bus in the new BRT system in Santiago, Chile and bi-articulated bus in Göteborg, Sweden. The new Volvo B6R midibus was presented in China together with an updated version of the Volvo 9300. In India, the Volvo B7RLE city bus was launched and an updated version of the Volvo 8300 was introduced in Mexico. In Europe, the Volvo 8700 BLEA articulated bus was launched.
 
The business area also continued its broadening of a complete offering to customers, including such actions as opening new Bus Service Centers and a continued focus on service contracts and financial solutions. Also during the year, the company began to offer customers assistance with the analysis and improvement of fuel consumption.
 
Production and capacity. During the year, Volvo produced 10,406 buses (8,089) and bus chassis. The chassis plant in Borås, Sweden, produced more complete chassis and kits than ever before and the plant in Wroclaw, Poland, manufactured a record number of buses.
 
Markets and Sales. Sales by Volvo Buses by principal geographic market area and operating income for the years 2004 and 2005 are set forth in the following table:
 
   
2004
 
2005
 
   
(In millions of SEK)
 
Western Europe
   
6,422
   
6,564
 
Eastern Europe
   
526
   
578
 
North America
   
2,960
   
4,247
 
South America
   
521
   
2,641
 
Asia
   
1,632
   
1,612
 
Other markets
   
661
   
947
 
Total sales
   
12,772
   
16,589
 
Operating income
   
158
   
470
 

Volvo delivered 10,675 buses and bus chassis during 2005, compared with 8,232 buses and bus chassis in 2004. Increased sales were reported in many markets, including Europe, North America, South America and parts of Asia.
 
During the year, Volvo Buses received an order for 1,779 city buses for the Transantiago BRT system in Santiago, Chile.
 
However, volumes were lower in China during the year, even though at the end of the year Volvo Buses received its largest order to date when Shanghai’s largest transport company, Shanghai Ba-Shi Group, ordered 2,000 buses. The order was for the Volvo B6R, Volvo’s new 10.5-meter long city bus. The buses will be delivered by the end of summer 2007.
 
Volvo’s market share was strengthened in nearly all markets, with the exception of China and Brazil. The company maintained its position as market leader in the Nordic region and in the UK. In Europe, the market share increased to 15.0% (14.1%) and in the North American coach segment market share rose to 19.9% (18.9%).
 
24

 
Volvo CE
 
The total market. In 2005, the total market for heavy and compact construction machines in Volvo Construction Equipment’s product segment rose by 10%. In North America, the market grew by 10%, Western Europe by 7%, while the other markets rose by 13%.
 
Total market growth was driven by both heavy and compact construction machines. The North American market for heavy construction machines grew 16%, while the market in Europe rose 4%. The other markets increased by 6%.
 
The total market for compact construction equipment grew in 2005 by 11%, compared with the preceding year. The North American market showed growth of 8% and the European market was up 8%. Other markets rose by 21%.
 
The Chinese market recovered from a temporarily low level, which is favorable for construction equipment in general and for the excavator business in particular. In contrast, the weak trend in Korea remained unchanged.
 
In total, Volvo CE increased its market share during the year due to new products and improved distribution. Deliveries increased by 13% and reached an all-time high level of more than 33,000 units.
 
General. Volvo CE has production facilities in Sweden, Germany, France, Poland, the US, Canada, Brazil, South Korea and China. Volvo CE’s products are sold and serviced through an extensive network of independent distributors and dealers worldwide, combined with Volvo CE’s own sales and marketing companies. Operations are focused on strong growth. The objective is to broaden the range of products, continue to penetrate new markets outside Europe and North America and implement programs directed at important customer segments. Services such as financing, handling of used equipment and information technology support in the sales and distribution process are also being intensively developed.
 
In 2005, Construction Equipment accounted for 15% of Volvo’s sales.
 
Business environment. The industry was characterized by a general upswing in 2005. Consolidation among small and medium-size manufacturers continued, although it has not progressed as far as the truck sector. The large players concentrated on launching new products, strengthening their presence in key growth markets and expanding their distribution networks.
 
Strategic development. Volvo CE’s ambitions for 2006 are to:
 
·  
Further develop excavator business.
 
·  
Capitalize on investments made in Korea, China and Germany.
 
·  
Continue to focus on the after-market and on rental operations, as well as reduce expenses for sales and administration.
 
·  
Continue the dealer development program.
 
·  
New products and services for new segments and customers.
 
Products. Volvo Construction Equipment’s products, spare parts and services are offered worldwide in more than 125 markets. Customers are using the products in a number of different applications including general construction, road construction and maintenance and in the refuse, mining and forestry industries.
 
Volvo Construction Equipment’s product portfolio includes wheeled and crawler excavators, articulated haulers, wheel loaders, motor graders and a range of compact equipment such as wheel loaders, excavators, backhoe loaders and skid-steer loaders. The pace of product renewal in the past few years has been high. The customer offering includes services such as financing, leasing and used equipment sales. Manufacturing facilities are located in Sweden, Germany, France, Poland, the US, Canada, Brazil, Korea and China.
 
25

 
Volvo Construction Equipment’s rental initiative, Volvo Rents, continues to develop favorably. During the year, about 40 new outlets were opened and the total number at year-end amounted to 116, with 65 in North America and 51 in Europe. A further 50 facilities are expected to open in 2006.
 
Markets and Sales. Sales by Construction Equipment by principal geographic market area and operating income for the years 2004 and 2005 are set forth in the following table:
 
   
2004
 
2005
 
   
(In millions of SEK)
 
Western Europe
   
12,443
   
14,213
 
Eastern Europe
   
1,010
   
1,311
 
North America
   
8,601
   
10,337
 
South America
   
922
   
1,238
 
Asia
   
4,961
   
5,717
 
Other markets
   
1,423
   
2,000
 
Total Sales
   
29,360
   
34,816
 
Operating Income
   
1,898
   
2,752
 

Production and capacity. To reduce costs and exploit synergies, Volvo Construction Equipment decided to institute joint management for wheel loaders and articulated haulers.
 
In March 2005 Volvo launched its largest excavator to date, the EC 700 B. This 70-ton excavator, which is manufactured in Korea, is in high demand. It is designed and tested to withstand extreme conditions during heavy work; for example, highway and water projects and large-scale loading and excavation in stone quarries. Volvo CE’s excavator business has performed very well since the acquisition of Samsung’s construction equipment division in 1998. Its annual volume has gone from approximately 5,000 machines to nearly 9,000 machines in 2005. A key component of Volvo Construction Equipment’s strategy is to expand in excavators, since it is the largest product area in the industry.
 
At year-end, an entirely new generation of motor graders was introduced - the G 900 series. It consists of seven machines weighing from 15.5 to 20.9 tons. All machines are equipped with Volvo V-ACT engines. The new motor graders will be manufactured at the Goderich, Canada plant.
 
Volvo Penta
 
The total market. The total market for large marine engines remained strong - however, demand for small engines subsided, due to lower demand for leisure boats in small-size classes. The world market for industrial engines was significantly lower than in the preceding year as a result of the sharp decline in the Chinese market. A recovery in global demand for industrial engines was noted, however, toward the end of the year.
 
General. By supplying technologically superior products focused on performance, operational reliability and environmental characteristics, and by being sensitive to customer demands for effective service solutions, Volvo Penta is a global leader and has one of the industry’s strongest brands. With more than 5,000 dealers in some 130 countries, Volvo Penta has a strong global presence.
 
Volvo Penta’s diesel engine business in Marine Leisure continued to grow in 2005. The addition of several new customers among boat builders in Europe and North America has strengthened Volvo Penta’s position as a world-leading supplier of diesel engines for leisure boats. In recent years in the US, Volvo Penta has strengthened its position significantly as a supplier of gasoline engines to independent boat builders. This trend continued in 2005. Volvo Penta’s sterndrive gasoline engines attracted special attention during the year for their high quality.
 
The plant in Vara in Sweden manufactures large diesel engines. Gasoline engines and drive systems are developed and manufactured in the United States.
 
In 2005, Volvo Penta accounted for approximately 4% of Volvo’s sales.
 
26

 
Business environment. Total volumes in the marine industry are considerably lower than in, for example, the automotive industry. Boat production has not yet undergone restructuring or standardization to the same degree as the production of passenger cars and trucks, however, the trend in the leisure boat industry has gained pace in recent years. Volvo Penta’s operations have recently become increasingly integrated with boat builders’ operations, particularly through specially adapted production and logistics solutions.
 
Due to the new Volvo Penta IPS power system, it is now possible to significantly rationalize boat production - a key success factor in the launch of the system.
 
In its Industrial and Marine Commercial segments, Volvo Penta endeavors to achieve the same type of integration with the manufacturer of the end-product, by promoting production efficiency.
 
Strategic development. Volvo Penta has implemented extensive product introductions in recent years. In 2006, the ambitions are to:
 
·  
Ensure more efficient production and logistics solutions for Volvo Penta customers.
 
·  
Ongoing focus on cost control and positive cash flow.
 
·  
Ensure the launch of the Volvo Penta IPS enjoys continuing success
 
Products. Volvo Penta offers complete drive systems and service for leisure boats, workboats and industrial applications such as diesel-powered generating equipment. Volvo Penta operates in three areas of activity: Marine Leisure, Marine Commercial and Industrial.
 
The award-winning new drive system for leisure and commercial boats - the Volvo Penta IPS (Inboard Performance System) - replaces traditional shaft installations for boats in the 35 to 50-foot class. The Volvo Penta IPS provides dramatic improvements in top speed, acceleration and comfort. The new joystick function enables Volvo Penta IPS boats to maneuver and dock in a secure manner, even in confined harbors. In the leisure boat industry several new boat models based on the Volvo Penta IPS were launched during the year. Toward year-end 2005, the new drive system was launched for boats in commercial operation as well.
 
Volvo Penta introduced a new 16-liter diesel engine, which is the most important engine segment for the commercial marine business.
 
Production and capacity. Capacity utilization at Volvo Penta plants was high during the year. In the second half of the year, measures were taken to reduce the number of temporary personnel at the diesel engine plant in Vara, Sweden, and the gasoline engine plant in Lexington, Tennessee, in the US - to ensure the ongoing favorable balance between production pace and demand.
 
At Volvo’s joint engine plant in Skövde, Sweden, Volvo Penta helped improve capacity utilization through sales of 12- and 16-liter engines.
 
Markets and Sales. The following table sets forth Volvo Penta’s sales by geographic market area and operating income for the years 2004 and 2005:
 
   
2004
 
2005
 
   
(In millions of SEK)
 
Western Europe
   
4,723
   
4,845
 
Eastern Europe
   
184
   
257
 
North America
   
2,500
   
2,832
 
South America
   
142
   
208
 
Asia
   
1,324
   
1,427
 
Other markets
   
184
   
207
 
Total sales
   
9,057
   
9,776
 
Operating income
   
940
   
943
 

Volvo Aero
 
The total market. Airline passenger traffic, having recovered in 2004, continued to improve in 2005. After the first eleven months, the increase in passenger traffic was 6%. Despite the increasing numbers of people flying today, the IATA still expects airlines to continue to report losses for 2005. There are large regional differences, however. European airlines and carriers in the Asia-Pacific region posted profits in 2005. The large American companies, on the other hand, continue to struggle with significant losses.
27

 
General. Volvo Aero develops and manufactures high-technology components for aircraft and rocket engines. In addition, it offers a broad range of services, including spare parts for aircraft engines and aircraft, sale, brokering and leasing of aircraft engines and aircraft, and maintenance and repair of aircraft engines. Volvo Aero also provides after-market services for gas turbines and turbine systems.
 
Volvo Aero has specialized its operations on developing and manufacturing certain selected components in aircraft engines. This is carried out in close cooperation with its corporate partners. Volvo Aero conducts operations on a global basis and has manufacturing plants in Sweden, Norway and the US.
 
In 2005, Volvo Aero accounted for approximately 3% of Volvo’s sales.
 
Business environment. Order bookings for large commercial aircraft basically increased in each month of the year. Airbus and Boeing announced a combined order intake of 2,140 orders in 2005 compared with 647 in 2004. Aircraft deliveries increased by 10% from 606 to 668 in 2005.
 
Strategic Development. For 2006, the ambitions are to;
 
·  
Meet challenges in design and manufacturing, particularly regarding the new GEnx engine.
 
·  
Continue precision delivery of engine components without losing focus on costs.
 
·  
New development assignments for the RM12 Gripen engine.
 
·  
Increase after-market volumes and profitability.
 
Products. Volvo Aero offers a wide range of services and products for the commercial, aerospace and military aircraft industries, including high-technology components for engines, sale of parts for engines and aircrafts and overhaul and repair of aircraft engines and gas turbine engines. In addition, Volvo Aero provides aftermarket services for gas turbine engines and systems.
 
The company operates in close cooperation with partners. In 2005, important contracts on engine programs, such as the new engine GEnx and the industrial gas turbine LM2500, were signed with General Electric. 
 
Production and capacity. During the year, cooperation with General Electric was increased. Volvo Aero and General Electric signed contracts whereby Volvo Aero increased its share in the LM2500 stationary gas turbine. Since 1997 Volvo Aero has been a risk-sharing partner on the LM2500, which became known as the most reliable gas turbine in its class. At the end of November, almost exactly one year after signing the contract for the new GEnx aircraft engine, Volvo Aero delivered the first components - right on schedule.
 
On February 12, 2005 the new Ariane 5 rocket, the ECA, was successfully launched. Since December 2002, working under intense time constraints, Volvo Aero has further developed the exhaust nozzle of the rocket, which can support a significantly greater usable load than before. The launch of the rocket was extremely significant for the ongoing European space program.
 
Volvo Aero Norway signed a contract with Pratt & Whitney to manufacture a component for the F135 engine for the F-35 JSF fighter aircraft.
 
Volvo Aero signed a contract with Snecma for the serial manufacture of nozzles and turbines for the Ariane 5. In addition, Volvo Aero and Snecma also signed a cooperation agreement to develop new turbine technologies for the aerospace industry.
 
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In April 2005 the world’s largest passenger aircraft, the Airbus A380, flew for the first time. The A380 has Trent 900-type Rolls Royce engines, an engine program in which Volvo Aero is part-owner. In addition Volvo Aero delivers components for the second engine alternative, the GP7000.
 
Markets and Sales. The following table sets forth Volvo Aero’s sales by geographic market area and operating income for the years 2004 and 2005:
 
   
2004
 
2005
 
     
(In millions of SEK)
 
Western Europe
   
3,130
   
3,346
 
Eastern Europe
   
49
   
60
 
North America
   
3,127
   
3,612
 
South America
   
138
   
168
 
Asia
   
400
   
284
 
Other markets
   
81
   
68
 
Total sales
   
6,925
   
7,538
 
Operating income
   
403
   
836
 
 
Financial Services
 
Volvo Financial Services (VFS) provides services in three main areas: customer finance and insurance, treasury operations and real-estate management. These services enable Volvo to apply a Group-wide approach to financial risk. They also play a key role in Volvo’s strategy for becoming the world’s leading provider of commercial transport solutions.
 
Volvo's expanding customer finance operations cover Europe, North America, Australia, and parts of South America and Asia. VFS conducts customer finance operations in more than 50 countries. Finance programs are offered to the dealers and end-customers of Volvo's business areas. The range of financial services includes installment contracts, financial and operational leasing, and the financing of dealers. In many markets insurance service and maintenance contracts are also offered separately or in combination with financing services.
 
Volvo’s internal bank, Volvo Treasury, coordinates the Group’s global funding strategy and financial infrastructure. It is responsible for the management of all interest-bearing assets and liabilities and the execution of foreign-exchange transactions. A diversified funding strategy kept the Group's borrowing cost at competitive levels and gave strong support to VFS's growing customer finance activities in 2005.
 
Operations within Danafjord, VFS’s real-estate unit, include the renting and development of commercial real estate in Sweden and, increasingly, in other countries. During the year, Danafjord sold some of its non-strategic property in Kalmar and Torslanda generating a gain of SEK 188 million. The occupancy rate at the end of 2005 was 99.9% (99.8), and 52% (52) of the total was accounted for by tenants outside the Volvo Group. 81% (84) of the leases extend for five years or more.
 
During 2005, VFS developed and launched a new strategic initiative called “Commercial Focus” (CF) to further improve its effectiveness and contribute greater value to the Group's Business Areas, its dealers and customers. The goals of CF are to integrate VFS's activities more closely with those of the other Business Areas, enhance the depth and breadth of VFS's services and develop how services are provided to key accounts. The first six of numerous global projects were started in 2005 to support these goals. VFS believes this initiative will increase its market share as it continues to maintain prudent pricing and credit levels.
 
Strategic development. For 2006 the ambitions for Financial Services are:
 
·  
Expand customer finance operations in growth markets.
 
·  
Closely monitor and adapt operations to economic conditions.
 
·  
Maintain low costs for funding the Group’s operations.
 
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Expanding credit portfolio. During 2005, the volume of new financing amounted to SEK 33 billion, up by more than SEK 3.5 billion compared with 2004.
 
On December 31, 2005, total assets amounted to SEK 86 billion (72 billion), of which SEK 79 billion (64 billion) related to the net credit portfolio. Adjusted for the effects of foreign-exchange movements, the credit portfolio grew by 10% during the year, compared with growth of 11% in the preceding year.
 
From a currency perspective, 37% of the portfolio was denominated in EUR, 35% in USD, 9% in GBP and 6% in CAD. The remaining 13% is primarily a mix of other European and Latin American currencies.
 
Suppliers
 
Volvo’s decision on whether to manufacture or to purchase from suppliers any particular component is made competitively on commercial terms. Although Volvo manufactures certain major components, including engines, transmissions and truck cabs, components are, to a large extent, purchased from suppliers outside of the Volvo Group. Increasingly, Volvo contracts with suppliers to manufacture an entire functional unit, such as completely finished seats, with the supplier assuming full responsibility for production to Volvo’s specifications. The primary prerequisites for cooperation with suppliers are near zero-defect quality level, competitive cost, and flexible and reliable delivery performance. Volvo also considers environmental matters in its selection of suppliers.
 
Sources and availability of raw materials. Volvo purchases raw materials, parts and components from numerous outside suppliers. A majority of the Group’s requirements for raw materials and supplies is filled by single-source suppliers. The impact of an interruption in supply will vary by commodity and components. Some parts are generic to the industry while others are of a proprietary design requiring unique tooling, which would take time to recreate. The inability of a supplier to deliver could have an adverse effect on production at certain of Volvo’s manufacturing locations.
 
The cost for raw material and components can vary significantly over the business cycle. These variations can occur due to changes in the commodity market or our suppliers' ability to deliver.
 
See “Item 3.D - Risk Factors - Volvo relies on suppliers for the provision of certain raw materials and components”.
 
Marketing
 
The greater part of the sales of Volvo’s products takes place in Europe, North America and Asia. Globally the majority of Volvo’s products is sold through independent dealers. In Europe a majority of Volvo’s products is sold through independent dealers but a significant part of sales is carried out through Volvo’s own dealer network. In North America products are sold mainly through independent dealers but Volvo also has a substantial part of direct sales to large fleet customers.
 
Research and Development
 
In 2005 and 2004, research and development expenses were SEK 7,557 million and SEK 7,614 million, respectively. Considerable research work is devoted not only to traditional product development, but also to developing effective software and total solutions designed to improve profitability in Volvo’s customer’s business.
 
New improved products Volvo's research and development focuses on its customers' business, environmentally adapted solutions and safety awareness. In the beginning of 2005 Volvo introduced two new truck models based on shared technology and architecture: Renault Magnum and Volvo VT880. In product development, all business areas and business units use a well-structured process with quality gates and milestones specifying the requirements that have to be fulfilled before a project is allowed to continue. Safety and environmental requirements are also key parameters in the process.
 
The focus on product quality in the development process as well as in the interface with the customer has led to improved results in customer satisfaction measurements.
 
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Safety in focus. Safety is one of Volvo's core values and research in this field has a high priority. Safety relates to the use of our products in society. We strive to minimize the risks and consequences of accidents, and to improve the safety and work conditions for vehicle operators. The Volvo Group has a strong commitment to provide customers with products that meet high demands on safety and we shall thereby be recognized as a leading producer of safe products, components and systems.
 
Safety aspects have a prominent role in all our product development and are based on an awareness of the user’s expected behavior. The basis for good safety is reliable and efficiently functioning products that respond in the anticipated manner. The user must be offered optimal conditions for handling the vehicle, even in complex situations.
 
The Volvo Group has made considerable progress in developing systems that help drivers to drive safely. For example, our trucks and buses can be equipped with electrically controlled disc brakes. These can be used in a stabilization system, Electronic Stability Program, ESP. Another example is the Adaptive Cruise Control, ACC, an electronic system that automatically adjusts the vehicle speed and distance in relation to the vehicle ahead.
 
Environmental improvement and utilization. Improved fuel efficiency results in lower costs for our customers and is an effective way to reduce emissions of carbon dioxide. In order to improve air quality, regulators in many countries are placing even more stringent requirements on reducing emissions, especially of nitrogen oxides and particulates.
 
In order to meet these demands, we are continuously developing new engine technologies that reduce fuel consumption and emissions. The harmful substances in emissions have been reduced by up to 85% over the past twenty years. Fuel consumption and carbon dioxide emissions have been cut by 30% over the same period.
 
Our products use primarily diesel engines, due to their energy efficiency and their potential for low emissions. While the primary focus is on developing diesel engines, Volvo has also made significant strides in the areas of alternative engine types and fuels. In the long term, we regard dimethylether as a possible fuel alternative. It can be used in the diesel process, has a high level of efficiency and can be produced from renewable raw materials.
 
Patents, Trademarks and Licenses
 
Volvo’s patents, trademarks, trade names and licenses are important to the business of each of the business areas within Volvo. Volvo owns or otherwise has rights to a substantial number of trademarks that it uses in conjunction with its business. Volvo believes that the level of protection of trademarks and other intellectual property rights used in its business is and has historically been adequate relative to its business. Volvo will use its best efforts to maintain the protection of such rights to the same extent in the future and is continuously evaluating and renewing its trademark and trade name registrations in all countries in which Volvo does any material amount of business. After the sale of Volvo Cars to Ford, the Volvo trademark is owned by Volvo Trademark Holding AB, which is jointly owned by AB Volvo and Volvo Car Corporation. The right to use the trademark “Volvo” has thereafter been regulated through license agreements made between Volvo Trademark Holding AB and AB Volvo and Volvo Car Corporation, respectively.
 
Volvo Car Corporation has the right to use the “Volvo” trademark for passenger cars, minivans carrying up to 10 passengers, light trucks with payload up to 1,500 kilograms, sports utility vehicles and other vehicles, but not buses or other vehicles used solely for commercial purposes, that have a gross vehicle weight of not greater than 5,400 kilograms (12,000 lbs. gross weight). AB Volvo has the right to use the trademark for trucks, buses, construction equipment, industrial and marine engines, aerospace equipment and all other products (apart from those which Volvo Car Corporation has the right to use the trademark for). To secure these rights and avoid having the trademark eroded, AB Volvo and Volvo Car Corporation have jointly adopted mechanisms to control their respective use of the trademark and to prevent others from taking undue advantage of it.
 
With regard to the “Mack” trademark, which is owned within the Volvo Group, similar control mechanisms apply. Volvo’s right to use the “Renault” trademark are limited to the truck sector only and are governed by a license agreement with the French company Renault SA, the owner of the “Renault” trademark.
 
31

Regulatory Matters
 
Environmental and Other Regulatory Matters
 
The corporate values of quality, safety and environmental care are present in the daily operations of the Volvo Group. Quality and environmental management systems are used in all parts of the organization as the means for addressing responsibility and objectives. The Group policies and a common network of environmental auditors monitor compliance with the Group guidelines and objectives.
 
During 2002, improved energy efficiency and lower emissions were defined as the focused environmental agenda for the entire Volvo Group, and objectives for the coming three-year period were developed.
 
Reduced emissions. The Volvo Group primarily uses diesel engines in its products, due to their high energy efficiency and their potential for low emissions. The main focus in development is on diesel engines. Improved fuel efficiency is an effective way of reducing carbon dioxide emissions, as well as reducing costs for the Group’s customers.
 
In order to improve air quality, regulators in many countries are placing even more stringent requirements on reducing emissions, especially of nitrogen oxides and particulates. In the US and the EU, among other places, the requirements are set to become considerably more rigorous during the next few years. All heavy trucks and buses registered in the EU from October 1, 2006 must meet the Euro 4 emissions standards. There are significant differences concerning exhaust emissions between an engine fulfilling the current Euro 3 requirements and one that meets the Euro 4 requirements. Emissions of nitrogen oxides (NOx) have to be reduced from 5 to 3.5 g/KWh, corresponding to a reduction of 30%. Particle emissions (PM) have to be reduced from 0.1 to 0.02 g/KWh, a reduction of no less than 80%. Euro 5, which will take effect on October 1, 2009 will require that NOx emissions levels in accordance with Euro 4 be halved.
 
To fulfill the new requirements for trucks and buses due to be introduced in Europe in 2006 (Euro 4) and 2009 (Euro 5), new solutions are needed for diesel engines. The Group’s solution to meet the requirements is diesel engines with even more efficient combustion and after treatment of exhaust gases with the additive AdBlue and Selective Catalytic Reduction (SCR). In North America, the Volvo Group has chosen to use an exhaust recirculation system - High-performance Exhaust Gas Recirculation (HEGR) - to reduce emissions of nitrogen oxides (NOx), combined with a diesel particulate filter.
 
Fuel efficiency is the main interest of all our customers, with its direct link to the operating costs of the business. Improved total fuel efficiency is also the most rewarding way to decrease carbon dioxide (CO2) emissions. How a vehicle is driven also has a significant effect on fuel consumption. For example, the same vehicle’s fuel consumption can vary by as much as 20% between different drivers. In some markets, the Volvo Group companies offer driver training programs that cover both fuel-efficient driving and safe driving.
 
At the same time to improve ambient air quality, increasingly stricter emission regulations put pressure on the engine development to decrease mainly nitrogen oxides (NOx) and particle emissions. Unfortunately, higher fuel efficiency normally means higher emissions of NOx, a physical fact resulting from higher combustion temperatures. This balance is the challenge for all the Volvo Group business areas.
 
The recent product launches demonstrate how the stricter emission requirements have been met with highly competitive fuel efficiency. Volvo Penta’s new medium-heavy marine diesel engines, D6-350 and D4-260, and the new D9, a future alternative to outboard engines demonstrate decreased fuel consumption combined with substantially lower emissions as well as advantages in terms of weight and noise levels. The key to this strategy is a close collaboration between engine development and each application, to ensure the right combination of engine, transmission, chassis and body. The I-shift transmission used in the Volvo Trucks is an example of this integration.
 
32

 
The Volvo Group's operations during 2005 were organized in eight business areas: Volvo Trucks, Renault Trucks and Mack Trucks, Buses, Construction Equipment, Volvo Penta, Volvo Aero and Financial Services. In addition to the eight business areas, there are certain operations, consisting mainly of service companies that are designed to support the business areas' operations. In the financial reporting the business areas Volvo Trucks, Renault Trucks and Mack Trucks are reported as one segment.
 
Each business area except Financial Services has total responsibility for its operating income and operating capital. The Financial Services business area has responsibility for its net income and total balance sheet within certain restrictions and principles that are established centrally.
 
The supervision and coordination of treasury and tax matters is organized centrally to obtain the benefits of a Group wide approach. The legal structure of the Volvo Group is based on optimal handling of treasury, tax and administrative matters and, accordingly, differs from the operating structure.
 
See “Item 18 - Financial Statements - Note 4” for information concerning Volvo’s group structure and significant subsidiaries, including the name, country of incorporation, proportion of ownership interest and, to the extent different, proportion of voting power held.
 
 
At December 31, 2005, the eight business areas of Volvo had manufacturing facilities worldwide.
 
Major components for the Group’s products are manufactured in Sweden, including engines, power transmission systems, cabs and sheet metal components.
 
Trucks are assembled in plants in Sweden, Belgium, France, Spain, Brazil, Venezuela, Australia, the United States, China, India and South Africa.
 
Volvo’s bus production takes place in Sweden, Finland, Poland, Brazil, Canada, Mexico, India, China and South Africa.
 
Facilities for production of construction equipment are located in Sweden, Germany, France, Poland, the United States, Canada, Brazil, South Korea and China.
 
Volvo Penta’s production facilities are in Sweden, United States and China.
 
The production facilities of Volvo Aero are located in Sweden, Norway and the United States.
 
The major part of the properties owned by the Volvo Group is used in the Group’s own operations. A certain number of the properties owned are leased to Volvo Car Corporation. The greater part of Volvo’s production facilities is owned by Volvo.
 
Volvo believes that the Group’s principal manufacturing facilities and other significant properties are in good condition and are adequate to meet the needs of the Volvo Group.
 
Environmentally adapted production. Environmental protection and responsible utilization of our shared natural resources are obvious aspects of Volvo’s production. The Volvo Group places environmental requirements on all facilities. These requirements include guidelines for the utilization of chemicals, energy use, emissions into the air and water, waste management, environmental organization and improvement efforts.
 
Since 1989, routine audits are conducted in order to monitor environmental efforts. Auditors identify environmental risks and any necessary measures that must be taken. Follow-up is conducted to ensure that work is completed. We have insurance coverage for environmentally related damages to the immediate surroundings, for example in the event of a sudden emission.
 
All of Volvo’s production facilities have the requisite environmental permits. In Sweden, there are 16 facilities that require permits. Those permits encompass waste, noise and emissions into the air, ground and water. One Swedish environmental permit is subject to renewal in 2006.
 
Freight. Air pollution from our own industrial operations is substantially lower than the emission from transport of goods to and from our production facilities. In order to encourage environmental improvement measures in our transport systems, Volvo Logistics, the Group's procurement company for transport services, continuously assesses the environmental work of contracted transport companies according to a classification system. Every new supplier contract includes an environmental clause whereby the transport company undertakes to operate in accordance with the ISO 9000 and ISO 14001 standards.
33


 
Not applicable.
 
34

 
 
The following operating financial review should be read in conjunction with the Company's Consolidated Financial Statements included herein. The Consolidated Financial Statements and the financial information discussed below have been prepared in accordance with International Financial Reporting Standards, IFRS, as adopted by European Union, EU. For a discussion of the principal differences between IFRS and US GAAP, see “Item 18.  Financial Statements—Note 37.”
 
General

The following table sets forth the Volvo Group’s sales and operating income by business areas for each of the years in the two-year period ended December 31, 2005.
 
   
2004
 
2005
 
Net sales
 
(In millions of SEK)
 
Trucks
   
136,879
   
155,396
 
Buses
   
12,722
   
16,589
 
Construction Equipment
   
29,360
   
34,816
 
Volvo Penta
   
9,057
   
9,776
 
Volvo Aero
   
6,925
   
7,538
 
Financial Services
   
9,598
   
7,549
 
Other and eliminations
   
6,535
   
8,895
 
Total, as reported
   
210,401
   
240,559
 
               
Operating income (loss) 1
             
Trucks
   
8,992
   
11,717
 
Buses
   
158
   
470
 
Construction Equipment
   
1,898
   
2,752
 
Volvo Penta
   
940
   
943
 
Volvo Aero
   
403
   
836
 
Financial Services
   
1,365
   
2,033
 
Other
   
923
   
-600
 
Total, as reported
   
14,679
   
18,151
 
____________
1
Operating income in 2004 included reversal of write-down of shares in Scania AB of 915, which was reported in Other and write-down of shares in Henlys Group plc of 95, which was reported in Buses.
 
Volvo’s investment in Scania AB
 
During 1999 and 2000, Volvo acquired 45.5% of the capital and 30.6% of the voting rights in Scania AB, one of the world’s leading manufacturers of trucks and buses. As a condition in connection with the European Commission’s approval of Volvo’s acquisition of Renault V.I. and Mack Trucks Inc. in 2001, Volvo undertook to divest its holding in Scania not later than April 2004. In April 2004, the Annual General Meeting approved a dividend to AB Volvo's shareholders of 99% of the shares in Ainax AB, a wholly owned subsidiary holding all of Volvo's Scania Series A shares. The distribution of shares in Ainax AB to Volvo’s shareholders was made on June 8, 2004 and the value of this dividend was SEK 6,310 million. Volvo has no longer any holdings in Scania AB or Ainax AB.
 
Volvo’s investment in Henlys Group plc

During 1998 and 1999, Volvo acquired 9.9% of the capital and voting rights in Henlys Group plc at a total acquisition cost of SEK 524 million. Henlys Group was a British company involved in manufacturing and distribution of buses and bus bodies in Great Britain and North America. Volvo and Henlys Group jointly owned the shares of the North American bus operations Prévost and Nova Bus. In February and March 2004, Henlys announced that its earnings for 2004 were expected to be significantly lower than previously anticipated. As a consequence of receiving this information, it was determined at the date when Volvo issued its 2003 financial statements that Volvo's holding in Henlys Group plc was permanently impaired at December 31, 2003, and a write-down was charged to Volvo’s operating income under Swedish GAAP for 2003. On June 10, 2004, Henlys Group announced that it was holding discussions with its lending banks and other principal creditors regarding a restructuring of the Henlys Group, and that it intended to delist its shares from the London Stock Exchange, Volvo wrote-down its remaining stake, SEK 95 million, in the second quarter 2004.
 
35

In October 1999, Volvo issued a convertible debenture loan to Henlys Group of USD 240 million in connection with Henlys Group’s acquisition of the US school bus manufacture Bluebird. The convertible debenture loan matured in October 2009. During the autumn 2004 Henlys Group was restructured. As part of the restructuring, Volvo Group reached an agreement to acquire the remaining 50% of the North American bus manufacturer Prévost Car Inc., containing the Prévost and Nova brands. The purchase price was SEK 554 million including two loans made available to Prévost Car Inc. by Henlys. In accordance with the agreement, Prévost Car Inc. became a wholly owned subsidiary of Volvo Bus Corporation. The agreement also involved Volvo converting part of the convertible debenture loan of SEK 1,601 million issued to Henlys into common and preferred shares in a newly established US-based company, Peach County Holdings Inc, containing the US school bus manufacturer Blue Bird. After the conversion Volvo owned 42,5% of the common shares in the new company. The conversion resulted in a write-down of approximately SEK 1.3 billion 2004, see “Item 18.  Financial Statements—Note 11.”
 
Peach County Holdings, Inc
 
During the fourth quarter of 2005 Volvo wrote down its shareholding in Peach County Holdings, Inc. by about SEK 550 M. At December 31, 2005 Volvo held 42.5% of the US-based company, which in turn owns the American school bus manufacturer Blue Bird. Since its reconstruction in the preceding year, Blue Bird has not developed well. The write-down was made as a consequence of Volvo’s decision not to participate in continued financing efforts. After the write-down, the value is zero. In January 2006, Peach County Holdings entered into reorganization proceedings (Chapter 11) and as a consequence of Volvo choosing not to participate in the continued reconstruction, Volvo’s shares in the company were cancelled.
 
Volvo and Renault agreement
 
In July 2000, AB Volvo reached an agreement with Renault S.A. to acquire Mack Trucks and Renault V.I., the truck operations of Renault, in exchange for 15% of AB Volvo's shares.
 
During 2001, AB Volvo and Renault S.A. entered into a dispute regarding the final value of the acquired assets and liabilities in Renault V.I. and Mack Trucks. The dispute was settled during the fourth quarter of 2004 and an amount of SEK 981 million has reduced the goodwill amount pertaining to the acquisition of Renault V.I.
 
Economic and market conditions. 2005 continued to be a strong year in global economic momentum. The economic expansion in the United States remained buoyant despite tighter monetary conditions. The Euroland economy failed to match the acceleration seen in 2004. Metal and oil prices appreciated sharply in 2005.
 
Overall, demand was very high in the markets in Europe, North America and South America. The total market for heavy trucks, based on the number of registered vehicles, in EU member countries plus Norway and Switzerland) rose 9% to 276,700 trucks in 2005, which is a new record level. Registration in the UK increased by 5%, in France by 21%, while the market in Germany was up 4% and in Spain by 10%. The market for heavy trucks in North America (Class 8) rose 29% in 2005 to 328,900 heavy trucks, compared with 255,500 trucks in 2004. This was driven by the continued strong US economy, with rising haulage needs. In addition, demand was driven by a need to renew truck fleets and that some customers wanted to purchase new trucks prior to the new, stricter emissions legislation becoming effective on January 1, 2007. The market for heavy trucks in Brazil declined by 9%. In 2005, the total market for heavy and compact construction machines in Volvo Construction Equipment’s product segment rose by 10%. In North America, the market grew by 10%, Western Europe by 7%, while the other markets rose by 13%. Total market growth was driven by both heavy and compact construction machines. The North American market for heavy construction machines grew 16%, while the market in Europe rose 4%. The other markets increased by 6%. The total market for compact construction equipment grew in 2005 by 11%, compared with the preceding year. The North American market showed growth of 8% and the European market was up 8%. Other markets rose by 21%. The Chinese market recovered from a temporarily low level, which is favorable for construction equipment in general and for the excavator business in particular. In contrast, the weak trend in Korea remained unchanged.
 
36

Factors affecting results. The Volvo Group’s sales are principally affected by unit sales volume and vehicle prices as well as by currency fluctuations, product mix and sales of optional equipment. The profitability of Volvo’s operations depends on a number of factors, including research and development expenses and the ability to achieve cost and capital efficiencies in product manufacturing.
 
Impact of Currency Fluctuations. A substantial amount of Volvo’s assets and debt are denominated in currencies other than Swedish kronor or located in countries other than Sweden. Most of Volvo’s sales take place outside Sweden with invoicing in U.S. dollars and other currencies. The sales outside Sweden amounted to, SEK 196,470 million and SEK 225,225 million, or 93% and 94% of Group sales in 2004 and 2005, respectively.
 
A large part of Volvo’s production takes place outside Sweden. In addition, a large percentage of the Group’s suppliers are located outside the production countries from which Volvo imports, among other things, parts and various raw materials, which may be invoiced in currencies other than kronor. Volvo’s sales and income, expressed in kronor, may be materially affected by fluctuations in the exchange rates between the kronor and the currencies in which the Group sells to customer or purchases from suppliers.
 
Changes in exchange rates have both dynamic and direct effect on income. The dynamic effects include the pricing of products sold and materials purchased in foreign currency. Changes in exchange rates also affect competitors and thus have an indirect impact on Volvo’s competitiveness. The direct effects arise mainly when income, expense, assets and liabilities in foreign currencies are translated to Swedish kronor at rates different than those used to translate financial items for an earlier period.
 
The average exchange rates between the Swedish krona and other major currencies such as the US dollar and the Euro were almost unchanged for 2005 compared to 2004.
 
The total effect of changes in currency exchange rates on operating income in 2005 compared with 2004 was positive by approximately SEK 100 million. The transactional effect of changed spot-market rates was positive, approximately SEK 1,000 million. The effect on income of forward and option contracts amounted to a loss of SEK 566 million (gain of SEK 828 million in 2004), which resulted in a negative impact of SEK 1,394 million for 2005, compared with 2004. Changes in spot rates in connection with the translation of income in foreign subsidiaries and the revaluation of balance sheet items in foreign currencies had a positive impact of SEK 651 million.
 
Adoption of International Financial Reporting Standards. From January 1, 2005, AB Volvo prepared its consolidated financial statements in accordance with IFRS. AB Volvo restated its financial statements from January 1, 2004 to IFRS. See Notes 1 and 3 to the consolidated financial statements. In addition, consolidated net income and stockholders’ equity are reported as reconciled to U.S. GAAP. Unless otherwise indicated, all amounts and percentages presented herein are based on IFRS. IFRS as applied by the Company differs in certain significant respects from U.S. GAAP. For a discussion of the significant differences between IFRS and U.S. GAAP affecting AB Volvo’s consolidated financials statements and reconciliation to U.S. GAAP of consolidated stockholders’ equity and consolidated net income as of and for the years ended December 31, 2005 and 2004, see Note 37 to the consolidated financial statements. As a result of AB Volvo’s transition to IFRS reporting, certain amendments have been made to the adjustments recorded in its reconciliation of net income and equity under US GAAP for the financial year 2004.
 
37

Results from continuing operations
 
2005 compared with 2004

Volvo Group. Net sales in 2005 amounted to SEK 240,559 million (211,076), an increase of 14% compared with a year earlier. Adjusted for changes in currency rates, net sales rose 11%. Net sales for the Group’s truck operations amounted to SEK 155,396 million, which adjusted for changed exchange rates corresponded to an increase of 11%. The increase was attributable to higher sales, primarily in North America, South America and Other markets. Demand in North America was driven by a continued strong US economy, which resulted in increased transport needs. In addition, there is a need to renew truck fleets, which certain hauling companies are doing prior to the new, stricter emission legislation becoming effective at the beginning of 2007. In Europe, demand rose somewhat from an already historically high level. In total, Volvo delivered 214,379 trucks in 2005, 11% more than in the preceding year.
 
Net sales within Buses rose 30% compared with 2004. Adjusted for currency effects and purchase of the outstanding 50% of Prévost and Nova Bus, the increase was 18%. The increase is attributable mainly to South America, where a large number of buses were delivered to the new, efficient rapid transit bus system in Santiago, Chile.
 
As a result of a broadened production range and improved market shares in a rising world market, net sales in Construction Equipment increased by 19%. Adjusted for currency effects and divested operations, the increase was 18%.
 
Volvo Penta succeeded in offsetting the reduction in deliveries of industrial engines to China through growing on other markets. Net sales rose 8% in 2005, or 7% adjusted for currency changes.
 
The recovery in the aerospace industry affected Volvo Aero positively and, after several years of reduced sales, net sales again increased. The upturn was 9% in 2005, and adjusted for changes in currency rates, the increase was the same.
 
Strong economic growth combined with a major need to replace ageing fleets of trucks and construction equipment contributed an increase of 28% in net sales in North America. The rate of growth in Europe was significantly lower for the Group, which is reflected in the weaker economic development in Europe in many important countries. Net sales in South America were up 71% as a consequence of the increased sales of mainly trucks and buses.
 
Operating income in 2005 increased 24% to SEK 18,151 million (14,679). Excluding a positive effect on operating income from revaluation of shares in Scania AB and Henlys Group of SEK 820 million in 2004, the increase was 31%. The improvement is due mainly to increased volumes, higher gross margins and a higher portion of capitalized development expenses.
 
Trucks reported operating income of SEK 11,717 million (8,992), up 30%. The increase is attributable primarily to North America, where Mack Trucks and Volvo Trucks increased profitability through a favorable price realization and increased volumes. In Europe, Renault Trucks continued to improve its earnings while profitability for Volvo Trucks’ operations in Europe declined somewhat from a favorable level. Operating income for the European truck operations was impacted by increased costs during the second half of 2005 as a consequence from launches and production changeovers in connection to the introduction of a new generation of trucks and engines.
 
Operating income in Buses continued to improve as a result of the restructuring implemented earlier and higher sales volumes, particularly in South America. Operating income for full-year 2005 was SEK 470 million, compared to SEK 158 million in 2004.
 
Through strong cost control and increased volumes, Volvo Construction Equipment continued to improve its profitability. Operating income rose by 45% to SEK 2,752 million in 2005.
 
Volvo Penta maintained its high profitability during 2005 and at the same time implemented aggressive investments in product development and substantial marketing efforts to capitalize on the new and competitive product portfolio. Operating income remained at the same level as in 2004, SEK 943 million (940).
 
As an effect of the recovery in the aerospace industry, volumes rose for Volvo Aero. Combined with a favorable product mix and price realization, this resulted in an increase in operating income of 107% to SEK 836 million in 2005.
 
Operating margin for the Volvo Group during 2005 was 7.5% compared to 7.0% 2004.
 
38

Trucks. Net sales for Volvo’s truck operations amounted to SEK 155,396 M, which adjusted for changed exchange rates corresponded to an increase of 11%. The increase was attributable to higher sales, primarily in North America, South America and Other markets. Demand in North America was driven by a continued strong U S economy, which resulted in increased transport needs. In addition, there is a need to renew truck fleets, which certain hauling companies are doing prior to the new, stricter emission legislation becoming effective at the beginning of 2007. In Europe, demand rose somewhat from an already historically high level. In total, Volvo delivered 214,379 trucks in 2005, 11% more than in the preceding year.
 
Research and development expenses for Trucks in 2005 amounted to SEK 5,200 million, compared with SEK 5,491 million in 2004.
 
Buses. Volvo delivered 10,675 buses and bus chassis (8,232) during 2005. Increased sales were reported in many markets, including Europe, North America, South America and parts of Asia. During the year, Volvo Buses received an order for 1,779 city buses for the Transantiago BRT system in Santiago, Chile.
 
Net sales during 2005 rose to SEK 16,589 million (SEK 12,722 million). The increase was attributable largely to increased sales and improved pricing. Operating income increased from SEK 158 M, including a write-down of shares SEK 95 million, to SEK 470 million.
 
The improved earnings were due to increased volumes, higher prices, prior restructuring and general cost reductions. Earnings were adversely affected by SEK 95 million in costs for the closure of the plant in Heilbronn, Germany.
 
Research and development expenses for Buses in 2005 amounted to SEK 569 million, compared with SEK 484 million in 2004.
 
Construction Equipment. Net sales rose by 19% to SEK 34,816 million (SEK 29,360 million). Adjusted for exchange-rate effects, the increase was 18%. The increase was attributable mainly to increased volumes, improved distribution and advantageous product and market mix.
 
Operating income improved by 45% during the year and amounted to SEK 2,752 million (SEK 1,898 million), which represents an operating margin of 7.9% (6.5%). The earnings and margin improvements are due to advantageous product and market mix, increased productivity and good control of selling and administrative expenses. A program to lower selling and administration expenses was launched in 2005 to strengthen the operating margin.
 
Research and development costs for Construction Equipment in 2005 amounted to SEK 1,083 million compared with SEK 1,033 million in 2004.
 
Volvo Penta. Sales rose by 8% to a total of SEK 9,776 million, compared with SEK 9,057 million in the preceding year, due mainly to the strong performance of the Marine Leisure segment. Volvo Penta maintained its high profitability during 2005 and at the same time implemented aggressive investments in product development and substantial marketing efforts to capitalize on the new and competitive product portfolio. Operating income remained at the same level as in 2004, SEK 943 million (940). The operating margin amounted to 9.6% (10.4).
 
Research and development costs for Penta in 2005 amounted to SEK 413 million compared with SEK 311 million in 2004.
 
Volvo Aero. Volvo Aero’s net sales rose by 9% to SEK 7,538 million (6,925). The sales increase comes primarily from increased volumes, particularly in component manufacturing.
 
Operating income amounted to SEK 836 million (403). The earnings improvement is mainly attributable to increased volumes and higher capacity utilization at the production plants in Trollh’ttan, Sweden and Kongsberg, Norway. Stronger demand for new spare parts and an advantageous product mix also contributed to the earnings improvement. Operating margin rose to 11.1% (5.8).
 
The most profitable segment is still the production of spare parts and components for commercial aircraft engines. The after-market contributed to the earnings improvement. Volumes continued to be low in the engine overhaul operations and profitability was unsatisfactory.
 
39

Research and development costs in Volvo Aero amounted to SEK 225 million in 2005, compared with SEK 209 million in 2004.
 
Volvo Financial Services, VFS. Operating income for VFS in 2005 amounted SEK 2,033 million, up 49% from the SEK 1,365 million reported in 2004. Return on equity was 15.3% (11.1), with a year-end equity ratio of 11.2% (11.6%). Throughout 2005, VFS successfully achieved a healthy balance among credit risk, volume, sales penetration and professional pricing. All customer finance regions improved performance over the prior year. Write-offs in 2005 totaled SEK 297 million, corresponding to an annualized write-off ratio of 0.40% (0.66). On December 31, total credit reserves amounted to SEK 1,751 million giving a credit-reserve ratio at year-end of 2.17%.
 
Other. Operating income in 2005 from the Group’s other operations included AB Volvo and certain internal service companies and amounted to a loss of SEK 600 million (gain SEK 923 million). Operating income from the Group’s other operations in 2004 included a revaluation of Scania shares with SEK 915 million. In 2005 other operations included effects from Celero Support AB that was divested with a capital gain of SEK 430 million. In total during 2005, Volvo’s holding in Peach County Holding, Inc. (Blue Bird) impacted operating income negatively with an amount of SEK 653 million including a write-down of SEK 550 million during the fourth quarter.
 
Net interest expense. The net interest expense for 2005 amounted to SEK 318 million compared to SEK 433 million for the previous year. The improvement is primarily a result of lower cost for the pension liability due to lower pension debt as a result of capital injections to the Group’s pension foundations.
 
Other financial income and expenses. Other financial income and expenses were positively impacted by marked-to-market revaluation of derivatives used for hedging of the customer finance portfolio. The positive revaluation impact is a result of higher long-term interest rates in the US and Canada and was for the full year SEK 251 million. There was no revaluation impact in 2004, as marked-to-market valuation was not applicable in IFRS before 2005.
 
Income taxes. During 2005, income tax expenses of SEK 4,908 million were reported, compared with SEK 3,129 million for 2004. The income tax expense was related to current and deferred tax expenses.
 
Minority interests. Minority interests in the Volvo Group were mainly attributable to Volvo Aero Norge AS (22%), Volvo Aero Services LP (5%) and Wuxi da Hao Power Co, Ltd (30%).
 
 
Cash flows relating to major acquisitions and divestments of subsidiaries are included in the consolidated cash flow from the point of acquisition or through to the point of divestment. The effects of changes in exchange rates on translation of foreign subsidiaries have also been excluded since these effects do not influence cash flow. For further information regarding the impact of changes in foreign exchange rates see “- 5.A. Operating Results - General - Impact of Currency Fluctuations”.
 
Cash flow from operating activities. Cash flow from operating activities decreased to SEK 14.0 billion in 2005 from SEK 15.3 billion in 2004. The decrease between 2005 and 2004 was mainly due to transfers made during the year to pension foundations, in the amount of SEK 4.4 billion and also due to strong sales growth.
 
Cash flow from/used in investing activities. Net cash used in investing activities in 2005 amounted to SEK 12.5 billion compared with SEK 0.8 billion in 2004.
 
40

Investments in fixed assets in 2005 amounted to SEK 10.3 billion compared to SEK 7.4 billion in 2004. Investments in fixed assets in Trucks, which amounted to SEK 6.8 billion (SEK 4.7 billion in 2004), were made to improve efficiency in the European industrial system, increase the number of service workshops for the dealer network in Europe, continued modification of the Hagerstown plant in North America for manufacturing of engines and transmissions and for a changeover for production of a new 13-litres engine in Skövde, Sweden, and a new 11-liter engine in Vénissieux.  the move of the assembly line for the MD9 and MD11 engines from Skövde, Sweden to Lyon, France. Capital expenditures increased in Construction Equipment from SEK 0.7 billion to SEK 0.9 billion, mainly for development of production plants and in tools and equipment for new products. In Volvo Aero the level of capital expenditures increased from 0.5 billion to SEK 0.8 billion. A major part of the investments relate to entrance fees to become a partner in the new GEnx engine and in the LM2500 industrial gas turbines, according to agreements with General Electric. Investments remained at the same level as last year in Buses at SEK 0.2 billion and decreased in Volvo Penta from SEK 0.3 billion to SEK 0.2 billion.
 
Investments in leasing assets amounted to SEK 4.5 billion in 2005 compared with SEK 4.4 billion in 2004.
 
Cash flow from investments in shares was positive SEK 0.3 billion in 2005 and positive SEK 15.1 billion in 2004. In 2004, SEK 14.9 billion was related to the divestment of the Scania B shares.
 
Net acquisitions of subsidiaries and other business units in 2005 had a positive effect on cash flow by SEK 0.7 billion. The amount includes among others the sale of properties in Danafjord and the sale of the service company Celero Support. Net acquisitions of subsidiaries and other business units in 2004 had a negative effect on cash flow by SEK 0.1 billion.
 
Interest-bearing receivables including marketable securities had a negative impact on cash flow by SEK 1.3 billion in 2005, SEK 6.4 billion in 2004.

Cash flow from financing activities. Net cash flow used in financing activities amounted to SEK 3.3 billion in 2005 and SEK 14.7 billion in 2004. Net borrowings increased during 2005 by SEK 3.6 billion. The new borrowing during the year, mainly through the issue of bonds, contributed SEK 42 billion (amortization of debt was SEK 33.4 billion). The decrease in loans during 2004 reduced liquid funds of net SEK 8.8 billion, of which new borrowing during the year contributed SEK 19.1 billion (amortization of debt was SEK 28.9 billion).
 
Cash dividends paid to AB Volvo shareholders in 2005 totaled SEK 5.1 billion and SEK 3.4 billion in 2004.
 
Repurchase of own shares in 2005 amounted to SEK 1.8 billion and to SEK 2.5 billion in 2004.
 
Change in cash and cash equivalents. The Group’s liquid funds decreased during 2005 by SEK 0.7 billion, of which changes in exchange rates increased liquid funds by SEK 1.1 billion. Liquid funds at year-end amounted to SEK 8.8 billion. Liquid funds were SEK 9.2 billion at December 31, 2004.
 
Net financial position is calculated as liquid funds and short-term and long-term interest bearing receivables reduced by short-term and long-term interest-bearing loans (including provisions for pensions and other post retirement benefits). Net financial position is focused on Volvo operations excluding Volvo Financial Services, since the net financial position in the customer finance companies is stable. For additional information on Volvo’s Financial Services operations see further on page 44.
 
Net financial position at December 31, 2005 was calculated as follows:
 
(in millions of SEK)
 
Volvo Group,
excl Financial
Services
 
Cash and cash equivalents
   
7,385
 
Marketable securities 1)
    28,662  
Short-term interest-bearing receivables and loans
   
6,292
 
Long-term interest-bearing receivables and loans
   
1,399
 
Financial assets
   
43,738
 
Loans
   
13,097
 
Provisions for pensions and other post-employment benefits
   
11,966
 
Financial liabilities
   
25,063
 
Net financial assets
   
18,675
 

The Group’s, excluding Financial Services, net financial position, which totaled net financial assets of SEK 18.1 billion at the beginning of the year, totaled net financial assets of SEK 18.7 billion at December 31, 2005. The increase was due primarily to positive cash flow from operating activities partly offset by dividends paid to AB Volvo shareholders, repurchase of own shares and effects of changes in accounting principles (IFRS). The net financial position including long-term and short-term customer financing receivables was for the Volvo Group, including Financial Services, SEK 16.4 billion for 2005.
 
41

The net financial position as a percentage of shareholders’ equity and minority interests was 23.7% at the end of 2005 compared with 25.8% at the end of 2004.
 
Volvo generally maintains lines of credit throughout the geographical areas where it conducts business. The unused portion of committed credit lines, which may be used without restrictions, amounted to approximately SEK 21 billion at the end of 2005. Of these facilities approximately SEK 20 billion consists of stand-by facilities with varying maturities up to the end of 2010.
 
Credit risks. Credit risks are related to customer credits, to the deposit of liquid funds and to engagements in derivative instruments. Credit risk depends on the creditworthiness of counterparts and is reduced through careful evaluation of their ability to fulfill their obligations.
 
Customer credits comprise of credit granted to agents and dealers as well as loans made to end-customers by customer-financing companies. In addition, an evaluation of the political and economic situation in the purchaser’s country is made in connection with export transactions. At year-end 2005, Volvo’s accounts receivable amounted to SEK 24.8 billion. The average age of these receivables was 34 days.
 
Operations are governed by common policies for credits and by rules for classifying customers. The credit portfolio is distributed properly among different categories of customers and different industries. Credit risks are managed through active monitoring and follow-up routines and, in appropriate cases, procedures for repossessing products. Allocations are also made to credit-risk reserves. The credit risk in customer financing is distributed among a large number of individual customers and dealers. Collateral is provided in the form of the products being financed. When issuing credit, an effort is made to balance risk exposure and expected yield. Total assets in the consolidated customer-financing companies, consisting mainly of current and long-term accounts receivable, amounted to SEK 81.5 billion in 2005 compared to SEK 67.1 billion in 2004.
 
The liquidity in the Group is invested mainly in local cash pools or directly with Volvo Treasury. Volvo Treasury invests the liquid funds in the money and capital markets. This concentrates the credit risk within the Group’s in-house bank. All investments must meet criteria for low credit risk and high liquidity. In accordance with Volvo’s credit policy, counterparts for both investments and transactions in derivatives must in general have received a rating of “A” or better from one of the well-established credit-rating institutions.
 
The derivative instruments used by Volvo to reduce its foreign-exchange and interest-rate risk in turn give rise to a counterparty risk, the risk that a counterparty will not fulfill its part of a forward or option contract, and that a potential gain will not be realized. Transactions with derivative instruments are mainly conducted via Volvo Treasury, which means that the counterparty risk is concentrated within the Group's in-house bank. Where appropriate, the Volvo Group arranges master netting agreements with the counterparties to reduce exposure.
 
Policies and procedures. The Volvo Group Financial Risk Policies form the basis for each Group company’s action program. Monitoring and control is conducted continuously in each company as well as centrally. Most of the Volvo Group’s financial transactions are carried out through Volvo’s in-house bank, Volvo Treasury, which conducts its operations within established risk mandates and limits.
 
Commercial exposure. The objective of the Volvo Group Currency Policy is to minimize the short-term impact of adverse exchange rate fluctuations on the Volvo Group’s operating income, by hedging the Group's forecasted transaction exposure, including firm flows. In order to meet the objective of the Volvo Group Currency Policy, forecasted currency flows representing firm exposure and forecasted exposure with a pre-fixed price in local currency should be hedged. Volvo uses forward exchange contracts and currency options to hedge these flows. In accordance with the Group’s currency policy, between 50% and 80% of the net flow in each currency is hedged for the coming 6 months, 30% to 60% for months 7 through 12 and firm flows beyond 12 months should normally be hedged.
 
Financial exposure. Loans and deposits in the Group companies are mainly made through Volvo Treasury in local currencies and financial currency exposure in the individual entities is thereby being minimized. Volvo Treasury uses various derivative instruments in order to provide deposits and lending in different currencies without increasing the company’s own risk. The Volvo Group’s net financial position is being affected by changes in currency rates because financial assets and liabilities are allocated between Group companies operating in different currencies.
 
42

Interest-rate risks. Interest-rate risks relate to the risk that changes in interest-rate levels affect the Group’s profit. By matching fixed-interest periods of financial assets and liabilities, Volvo reduces the effects of interest-rate changes. Interest-rate swaps are used to change the interest-rate periods of the Group’s financial assets and liabilities. Exchange-rate swaps make it possible to borrow in foreign currencies in different markets without incurring currency risks.
 
Volvo also holds standardized futures and forward-rate agreements. The majority of these contracts are used to secure interest levels for short-term borrowing or deposits.
 
Liquidity risks. Volvo ensures maintenance of a strong financial position by continuously keeping a certain percentage of sales in liquid assets. A proper balance between short- and long-term borrowing, as well as the ability to borrow in the form of credit facilities, are designed to ensure long-term financing.
 
Non-current liabilities. Volvo Treasury AB and Volvo Group Finance Europe BV issue most of the Group’s non-current liabilities. The total outstanding non-current liabilities, excluding current portion as per year-end amounted to SEK 43.6 billion (SEK 40.4 billion). The material currencies issued were the Euro, US dollar, Swedish kronor, Pound Sterling and Canadian dollar amounting to SEK 22.6 billion, SEK 8.0 billion, SEK 5.5 billion, SEK 1.8 billion and SEK 1.9 billion, respectively.
 
Most of Volvo’s non-current liabilities are issued with a fixed interest rate, with currency and interest rate risk hedged using derivative instruments.
 
The maturity structure of the Group’s non-current liabilities is set considering the long-term funding needs within the Group. Approximately 72% mature within two to three years, 20% within four to five years and 8% within six years or later. See Note 26 to Volvo’s consolidated financial statements.
 
Residual value risks. Residual-value risk is attributable primarily to contracts involving buy-back or trade-back commitments, residual value guarantees or operational lease contracts. It comprises the risk that the product, at the end of the contract period, has another residual value than foreseen when the contract was entered. This may force Volvo to dispose of used products at a loss. Residual-value risks are managed within Volvo's business areas through solid knowledge of the market, knowledge of product and price trends, and programs supporting the value of second-hand products. It is Volvo’s policy to provide for this exposure on a continuing basis, so that the book value of these vehicles are in line with current and anticipated future price levels on used commercial vehicles.
 
Repurchase of shares of AB Volvo. The total number of outstanding Volvo shares by year-end 2003 was 419,444,842. The average number of outstanding shares was 419,444,842 in 2003. On April 16, 2004, the Annual General Meeting resolved that Volvo may transfer treasury stock to fulfill undertakings for the Company’s employee stock options program of 2002. Furthermore, the Meeting decided to establish a new share-based incentive program during the second quarter of 2004 for senior executives in the Volvo Group and it was resolved that Volvo may transfer own shares to the participants in the new share-based incentive program. The Annual General Meeting of AB Volvo also authorized the Board of Directors to decide on the acquisition of own shares for, among other reasons, to create a more effective capital management for AB Volvo. Accordingly, on June 16, 2004, the Board decided to acquire through purchase on Stockholmsbörsen a maximum of 22,076,045 Series A and/or Series B shares, however, not to exceed a total purchase amount of SEK 4.3 billion.
 
The purchases were carried out during the period October 27, 2004, up until March 1, 2005. The repurchases were made within the so-called spread and settlements were reported via Stockholmsbörsen in accordance with applicable rules.
 
By year-end 2004, a total of 9,315,000 Volvo A and B shares were repurchased for a total amount of approximately SEK 2,532 million. The total number of shares held by Volvo as treasury stock at year-end was 31,391,043 or 7,1% of the registered shares. The weighted average number of shares outstanding during 2004 was 418,528,773. In 2005 the repurchasing of shares continued and an additional 5,730,000 shares equivalent to SEK 1,763 million were repurchased during the period up until March 1, when the purchasing of own shares was finalized. On March 1, 2005 Volvo held a treasury stock of own shares to the equivalent of 8.4% of registered shares.
 
43

Volvo transferred a total of 63,667 of own shares to the holders of the share-based incentive program in April 2005. During 2005 share capital was reduced by SEK 95 million through cancellation without repayment of 3,084,619 Series A shares and 12,752,222 Series B shares. After reduction share capital amounts to SEK 2,554 million and is based on 425,684,044 registered shares. The total number of registered shares by year end 2005 amounted to 425,684,044. Volvo held 5% of the registered shares at year end 2005, 21,220,535 shares whereof Series A shares 4,145,627 and Series B shares 17,074,908.
 
Capital Expenditures for Property, Plant and Equipment. 

Capital expenditures that had been approved but not yet implemented at year-end 2005 amounted to approximately SEK 7.8 billion. The distribution of these investments, by principal business areas, is as follows:
 
   
(in billions of SEK)
 
       
Trucks
   
5.5
 
Buses
   
0.2
 
Construction Equipment
   
0.6
 
Volvo Penta
   
0.2
 
Volvo Aero
   
0.5
 
Other and corporate expenditures
   
0.8
 
Total
   
7.8
 

Historically, Volvo’s principal method of financing capital expenditures has been with funds provided by operations, supplemented by outside borrowings as required. These sources of financing will continue to be utilized. Volvo has sufficient working capital to meet its needs for the foreseeable future.
 
Financial Services operations

Supplementary income statements and balance sheets
 
In the supplementary income statements and balance sheets below, all Financial Services activities are separated from Volvo’s other operations in order to show how the activities have developed.
 
Condensed income statements, Financial Services
 
2004
 
2005
 
   
(In millions of SEK)
 
Net sales
   
9,598
   
7,549
 
Income after financial items
   
1,365
   
2,033
 
Income taxes
   
(430
)
 
(609
)
Net income
   
935
   
1,424
 
 
The condensed balance sheets below are presented for the Total Volvo Group as well as separately for Financial Services and for the Volvo Group excluding Financial Services. Separate condensed balance sheets are presented for Financial Services and for Volvo’s industrial and commercial operations (“Volvo Group excluding Financial Services”) since the capital structures of these operations are significantly different and therefore this additional information is requested from shareholders and creditors in order to be able to better evaluate the financial position of the Volvo Group. The Volvo Group’s financial targets as established by its Board of Directors further include separate targets for the capital structure within Financial Services and Volvo’s industrial and commercial operations.
 
44



 
 
Volvo Group, excl
Financial Services 1
 
 
Financial Services 
 
Total Volvo Group 
 
 Condensed balance sheets  
2004
 
2005
 
2004 
 
2005 
 
2004 
 
2005 
 
Assets
                         
Intangible assets
   
16.6
   
20.3
   
0.0
   
0.1
   
16.6
   
20.4
 
Property, plant and equipment
   
27.3
   
31.3
   
3.9
   
3.7
   
31.2
   
35.0
 
Assets under operating leases
   
8.5
   
10.3
   
12.8
   
0.7
   
19.5
   
20.8
 
Shares and participations
   
10.1
   
10.3
   
0.2
   
0.0
   
2.0
   
0.8
 
Long-term customer finance receivables
   
0.1
   
0.7
   
25.2
   
39.1
   
25.2
   
31.2
 
Long-term interest bearing receivables
   
1.8
   
1.4
   
0.0
   
0.0
   
1.7
   
1.4
 
Other long-term receivables
   
6.4
   
7.2
   
0.2
   
0.3
   
6.0
   
7.0
 
Inventories
   
28.3
   
33.6
   
0.3
   
0.3
   
28.6
   
33.9
 
Short-term customer finance receivables
   
0.1
   
0.6
   
26.1
   
38.9
   
26.0
   
33.3
 
Short-term interest bearing receivables
   
10.3
   
6.3
   
0.0
   
0.0
   
1.6
   
0.5
 
Other short-term receivables
   
30.0
   
36.8
   
1.6
   
1.6
   
29.7
   
35.9
 
Marketable securities
   
25.9
   
28.7
   
0.1
   
0.2
   
26.0
   
28.8
 
Cash and bank accounts
   
8.8
   
7.4
   
0.9
   
0.9
   
8.8
   
8.1
 
Total assets
   
174.2
   
194.9
   
71.5
   
85.8
   
222.9
   
257.1
 
                                       
Shareholders’ equity and liabilities
                                     
Shareholders’ equity
   
69.6
   
78.8
   
8.3
   
9.6
   
69.6
   
78.8
 
Provisions for post employment benefits
   
14.2
   
12.0
   
0.0
   
0.0
   
14.2
   
12.0
 
Other provisions
   
14.0
   
17.1
   
0.9
   
1.3
   
14.9
   
18.5
 
Loans
   
14.0
   
13.1
   
57.8
   
70.0
   
61.8
   
74.9
 
Other liabilities
   
62.4
   
73.9
   
4.5
   
4.9
   
62.4
   
72.9
 
Total shareholders’ equity and liabilities
   
174.2
   
194.9
   
71.5
   
85.8
   
222.9
   
257.1
 
Shareholders’ equity and minority interests as percentage of total assets
   
40.0
   
40.4
   
11.6
   
11.2
   
31.3
   
30.6
 
                                       
____________
1
Financial Services operations are reported in accordance with the equity method.
 
Net sales and income. The net sales value consists mainly of interest income and fees for rental and leasing contracts. Total sales of SEK 7,549 million in 2005 were 21% lower than in 2004.
 
Income after financial items amounted to SEK 2,033 million (SEK 1,365 million). Throughout 2005, VFS successfully achieved a healthy balance among credit risk, volume, sales penetration and pricing. All customer finance regions improved performance over the prior year.
 
At year-end 2005 the credit portfolio amounted to SEK 79 billion (SEK 64 billion). Excluding currency effects, the portfolio growth was 10.0% (10.8%). Provision is made for both credit risks and residual-value risks to the degree that residual-value risks are attributable to the customer-financing company. For customers unable to fulfill their contractual obligations, specific provisions for credit risks are made based on an individual assessment of each contract. In addition, in accordance with established policies, provisions are made for estimated credit and residual value losses for each customer-financing company.
 
Provisions for estimated credit value losses amounted to 2.2% (2.1%) of the credit portfolio at year-end 2004. Realized credit losses in 2005 amounted to SEK 297 million (SEK 429 billion).
 
Financial position. Total assets in Financial Services operations increased during the year, to SEK 85.8 billion from SEK 71.5 billion in 2004. 35% of the credit portfolio is denominated in USD and 37% in Euro.
 
45

Customer and leasing receivables amounted to SEK 78.0 billion compared to SEK 63.4 billion in 2004. Assets under operating leases decreased from 0.8 billion in 2004 to SEK 0.7 billion in 2005.
 
Volvo’s objective is to maintain an equity/assets ratio of 10% in its Financial Services operations. The equity/assets ratio, calculated as shareholders’ equity and minority interests as percentage of total assets was 11.2% in 2005, compared to 11.6% in 2004.
 
U.S. GAAP information
 
The Volvo Group’s financial statements have been prepared in accordance with IFRS, which vary in some respects from U.S. GAAP. Note 37 to Volvo’s consolidated financial statements for 2005 summarizes the effect that the application of U.S. GAAP would have on consolidated net income and shareholders’ equity. Also see Note 37 to Volvo’s consolidated financial statements for discussion of the impact of recently issued US accounting pronouncements.
 
Critical Accounting Policies and Estimates
 
Volvo’s significant accounting principles are set out on pages F-7 to F-11 of the consolidated financial statements and conform to IFRS as adopted by the EU. In note 2, Key sources of estimation uncertainty, to the consolidated financial statements, corresponding information to Critical Accounting Policies and Estimates are included. In accordance with Financial Reporting Release No. 60 (FR60) issued by the Securities and Exchange Commission of the United States, registrants are required to provide additional disclosure of accounting principles in which estimates, judgments and assumptions are particularly sensitive and which, if actual results are different, may have a material impact on the financial statements. The note 2 applied by Volvo are deemed to meet these criteria.
 
Introduction of new accounting policies
 
For a description of changes in accounting principles see “Item 18 - Financial Statements - Note 1”. For a description of changes in US generally accepted accounting principles see “Item 18 - Financial Statements - Note 37”. The financial impacts of the transition to IFRS are described in note 3, Impact of IFRS, to the consolidated financial statements.
 
 
For a description of the Company’s research and development activities for the last two years, see “Item 4. Information on the Company — 4.B Business Overview - Research and Development.” For a description of the Company's patents and licenses, see “Item 4. Information on the Company — 4.B Business Overview - Patents, Trademarks and Licenses.”
 
Research and development expenses in 2005 amounted to SEK 7,557 million compared with SEK 7,614 million in 2004. In accordance with IAS 38 intangible assets, expenditures for development of new products and production systems shall be reported as intangible assets if such expenditures with a high degree of certainty will result in future financial benefits for the company. The acquisition value for such intangible assets shall be amortized over the estimated useful life of the assets. The application of IAS 38 means that high demands are established in order for these development expenditures to be reported as assets. For example, it must be possible to prove the technical functionality of a new product prior to this development being reported as an asset. In normal cases, this means that expenditures are capitalized only during the industrialization phase of a product development project. Other research and development expenses are charged to income as incurred. See further in Notes 1 and 3 to the Consolidated Financial Statements.
 
 
For a discussion of trend information see “Item 5. Operating and Financial Review and Prospects - 5.A. Operating Results.”
 
46

 
 
The Group’s off-balance sheet arrangements at December 31, 2005 include:
 
i.  
guaranteed bank loans and other credits for associated companies in an amount of SEK 13 million.
 
ii.  
guaranteed bank loans and other credits for customers and others in an amount of SEK 1,267 million.
 
iii.  
tax claims in an amount of SEK 695 million for actual or anticipated actions against the Volvo Group for which provisions are not considered necessary.
 
iv.  
other contingent liabilities amounting to SEK 5,875 million.
 
See “Item 18 - Financial Statements - Note 29”
 
 
Long-term financial obligations include:

(in millions of SEK)
 
Payments Due by Period
 
   
 
Total
 
Less than 1 year
 
1-3
years
 
4-5
years
 
After 5
years
 
Long-term debt, including current maturities and financial lease obligations (a)
   
64,781
   
21,226
   
31,287
   
8,839
   
3,429
 
Operating leases
   
3,361
   
1,018
   
929
   
701
   
713
 
Total
   
68,142
   
22,244
   
32,216
   
9,540
   
4,142
 
 
(a) as recognized in Volvo’s Consolidated Balance Sheet as of December 31, 2005.

At December 31, 2005, Volvo further had commitments to repurchase used products through buy-back contracts and residual value guarantees with external customers in an amount of SEK 3,959 million (these commitments are reflected in Volvo's consolidated financial statements either as non-current liabilities, current liabilities or contingent liabilities).

The Volvo Group has no contractual obligations to contribute, during 2006, to Volvo related pension funds. The future payments will be influenced by future actuarial assumptions and could not thus be estimated. More about Volvo pensions could be found in F-pages note 24, Post-employment benefits.
 
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Corporate bodies in corporate governance
 
The governance and control of the Volvo Group is carried out through a number of corporate bodies. At General Meetings, the shareholders exercise their voting rights with regard, for example, to the composition of the Board of Directors of AB Volvo and election of external auditors. An Election Committee proposes candidates to serve as Board members, Board Chairman and external auditors. The Board is responsible for the Group’s long-term development and strategy as well as controlling and evaluating the company’s daily operations. In addition, the Board appoints the President of AB Volvo, who is also the Chief Executive Officer (CEO). The duties of the Board are partly exercised through its Audit Committee and its Remuneration Committee. The CEO is in charge of the daily management of the Group in accordance with guidelines and instructions provided by the Board. The presidents of the Group’s eight business areas report to the CEO.
 
Swedish Code of Corporate Governance
 
Volvo applies the Swedish Code of Corporate Governance (“the Code”).
 
Election Committee
 
The Election Committee is the shareholders’ body responsible for submitting to the Annual General Meeting the names of candidates to serve as Chairman and other members of the Board, the fees to be paid, distributed among the Chairman, other members of the Board and any remuneration for work on the Board’s committees. In the years in which election of auditors for Volvo shall be held, the Election Committee presents proposals for election of auditors and audit fees to be paid based on the preparations carried out by Volvo’s Audit Committee.
 
In conjunction with the Election Committee proposing candidates for Chairman and the other members of the Board, the Election Committee shall comment on whether those persons who are proposed are to be considered as independent in relation to the company and company management as well as to large shareholders in the company. The Election Committee’s proposal shall be presented to Volvo in sufficient time to be able to be included in the notice of the Annual General Meeting and at the same time on Volvo’s website.
 
The Election Committee, which was appointed at Volvo’s Annual General Meeting in 2005, comprised Volvo’s Chairman Finn Johnsson, Lars Idermark, representing the Second Swedish National Pension Fund, Marianne Nilsson, representing Robur Funds, Curt Källströmer, representing Svenska Handelsbanken and Thierry Moulonguet, representing Renault SAS. The Election Committee internally selected Lars Idermark as Chairman. The work of the Election Committee was during 2005 governed by the instructions approved by the Volvo Annual General Meeting in 2005. The 2006 Annual General Meeting elected the Board Chairman Finn Johnsson, Curt Källströmer, Eva Halvarsson, representing the Second Swedish National Pension Fund, Björn Lind, representing SEB-fonder and others, and Thierry Moulonguet as members of the Election Committee.
 
Board of Directors
 
In 2005, Volvo’s Board of Directors consisted of eight members elected by the Annual General Meeting. In addition, the Board had three members and two deputy members appointed by employee organizations. The CEO, Leif Johansson, was a member of the Board.
 
The Board held six regular meetings and three extraordinary meetings in 2005.
 
The Board has adopted work procedures for its activities that contain rules pertaining to the distribution of work between the Board members, the number of Board meetings, matters to be handled at regular meetings of the Board and duties incumbent on the Chairman. In addition thereto, the work procedures contain directives concerning the tasks of the Audit Committee and the Remuneration Committee respectively. The Board has also issued written instructions specifying when and how information required to evaluate the company’s and Group’s financial position should be reported to the Board as well as the distribution of duties between the Board and the President and in what circumstances the Executive Vice President and Deputy CEO is to substitute for the CEO.
 
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The Annual General Meeting decides on the fees to be paid to the Board members elected by the shareholders. The Annual General Meeting held on April 12, 2005 approved a total fee to the Board, for the time until the end of the next Annual General Meeting, of SEK 4,775,000. The fee was to be distributed among the Board Members according to the following. The Chairman of the Board receives a fee of SEK 1,350,000, the remaining members a total of SEK 2,700,000 to be distributed among the members as the Board decides. In addition, the Chairman of Audit Committee shall receive SEK 250,000 and the other two members of the Audit Committee SEK 125,000 each and the members of the Remuneration Committee SEK 75,000 each.
 
During the year, the Board reviewed the business plans and strategies for the various businesses in the Volvo Group. In addition thereto, the Board reviewed the financial positions of AB Volvo and the Volvo Group on a regular basis and acted in order to ascertain that there are efficient systems in order to follow-up and control the business and financial position of the Volvo Group. In connection therewith, the Audit Committee is responsible for preparing for the Board’s work through quality assurance of the company’s financial reporting through reviewing the interim reports and the annual report. The Board has met with the company’s auditors during 2005. The Board also dealt regularly with matters involving divestments, acquisitions, the establishment of new operations, and matters related to investments in product renewal and product development in the Group’s business areas.
 
The Board’s work is mainly performed through the Board meetings and through meetings in the respective committees of the Board. In addition thereto, the chairman of the Board is in regular contact with the CEO in order to discuss the on-going business and to ensure that the decisions taken by the Board are executed.
 
During 2005, the Board performed its yearly evaluation of the Board’s work. The written report has been submitted to the Election Committee.
 
Independence Requirements
 
The Board of Directors of Volvo must meet independence requirements pursuant to the rules of the Stockholm Stock Exchange, the Code and NASDAQ’s regulations, as well as the Sarbanes-Oxley Act.
 
Audit Committee
 
In December 2002, the Board established an Audit Committee primarily for the purpose of overseeing the accounting and financial reporting processes and the audit of the financial statements. The Audit Committee is responsible for preparing the Board’s work through quality assurance of the company’s financial reporting through reviewing the interim reports and the annual report. In addition, the Audit Committee’s task is to establish guidelines specifying what other services than audit the company may procure from the company’s auditors and to provide guidelines for and decisions on transactions with companies and persons closely associated with Volvo. The Audit Committee is also responsible for evaluating the auditors’ work as well as to provide the Election Committee with the results of the evaluation and to assist in preparing proposals for auditors.
 
In 2005, the Audit Committee comprised Board members Haruko Fukuda, Ken Whipple and Per-Olof Eriksson, Chairman. The Audit Committee held three ordinary meetings and one extraordinary meeting in 2005. The Audit Committee met with the external auditors and Head of Internal Audit at the ordinary meetings as well as the external auditors without the presence of the company management.
 
As of April 5, 2006, the Audit Committee consists of Per-Olof Eriksson, Ying Yeh and Peter Bijur. The Board of Directors has determined that each of Per-Olof Eriksson, Ying Yeh and Peter Bijur are “audit committee financial expert” as defined in Item 16A of Form 20-F.
 
Remuneration Committee
 
In April 2003, the Board established a Remuneration Committee primarily for the purpose of preparing and deciding on issues relating to remuneration to senior executive in the Group. The duties of the Committee include presenting recommendations for resolution by the Board regarding terms of employment and remuneration for the President and Executive Vice President of AB Volvo, principles for remuneration, including pensions and severance payment for other members of the Group Executive Committee, and principles for variable salary systems, share-based incentive programs, pensions and severance payment for other senior executives in the Group. In addition the Remuneration Committee decides the individual terms of employment for the other members of the Group Executive Committee in accordance with the principles established by the Board.
 
49

In 2005, the Remuneration Committee comprised Board members Tom Hedelius, Louis Schweitzer and Finn Johnsson, Chairman. The Remuneration Committee held four meetings during the year.
 
Disclosure Committee
 
A Disclosure Committee was established in 2004. The Committee contributes to ensuring that Volvo fulfills its obligations according to applicable legislation as well as to listing rules to timely disclose to the financial market all material information that affects the share price.
 
The Committee comprises the heads of the corporate staffs, Corporate Finance, Internal Audit, Investor Relations, Corporate Legal and Financial Reporting.
 

50

The Directors and Deputy Directors of AB Volvo during the full year 2005, their respective ages, the years in which such positions were attained and their material memberships on the Boards of other companies are: 

Name
Age
Position and Other Directorships
Finn Johnsson
 
60
 
Chairman of the Board (since February 2004). Director (since 1998). Chairman of the Remuneration Committee. Chairman of the Boards of, Outokumpu Copper Oy, Thomas Concrete Group AB, Unomedical A/S, KappAhl AB and City Airline. Member of the Boards of Skanska AB and AB Industrivärden.
 
     
Per-Olof Eriksson
 
68
 
Director (since 1994). Chairman of the Audit Committee. Master of Engineering, Hon. Dr. of Technology. Board Chairman: Callans Trä AB and Odlander, Fredriksson & Co. Board member: Investment AB Öresund, Assa Abloy, Senea AB, Elkem AS, Södersjukhuset AB, Cross country Systems AB and KTH Holding AB. Member of the Royal Swedish Academy of Engineering Sciences.
 
     
Patrick Faure
 
60
 
Director (since 2001). Bachelor of Laws. Chairman and CEO of Renault F1 Team. Board member: VINCI, ERTICO.
     
Haruko Fukuda
 
60
 
Director (since 2003). Member of the Audit Committee. Caliber Global Investment Ltd. (Chairman), Investec plc, Aberdeen Asian Smaller Companies Investment Trust plc. Senior Advisor at Lazard, Advisor at METRO AG. Honorary Fellow of New Hall Cambridge, Chairman of the Advisory Board of New Hall Cambridge, Honorary Vice President of the Japan Society, Trustee of Mitsubishi Trust Oxford Foundation, Freeman of the City of London.
     
Tom Hedelius
 
67
 
Director (since 1994). Member of the Remuneration Committee. Master of Business Administration, Hon. Dr. of Economics. Board Chairman: AB Industrivärden, Bergman & Beving AB and Sandrews. Honorary Chairman: Svenska Handelsbanken. Vice Chairman: Addtech AB, Lagercrantz Group AB and Jan Wallanders och Tom Hedelius stiftelse. Board member: Svenska Cellulosa Aktiebolaget SCA and Lundbergs AB.
 
     
Leif Johansson
 
55
 
Director (since 1997). Master of Engineering. President of AB Volvo and Chief Executive Officer of the Volvo Group since 1997. With Volvo since 1997. Board member: Bristol-Myers Squibb Company, Confederation of Swedish Enterprise and The Association of Swedish Engineering Industries. Member of the Royal Swedish Academy of Engineering Sciences.
 
     
Louis Schweitzer
 
64
 
Director (since 2001). Member of the Remuneration Committee. Bachelor of Laws. Board Chairman: Renault SA and AstraZeneca Plc. Board member: Philips, Electricité de France, BNP-Paribas, VEOLIA and L’Oréal.
 
     
Ken Whipple
 
72
 
Director (since 2001). Member of the Audit Committee. Bachelor of Business and Engineering. Board Chairman of CMS Energy Corporation and Glenlore Enterprises. Board member: 14 JP Morgan Fleming Mutual Funds and Korn-Ferry International AB.
 
     
Martin Linder*
33
 
Director (since May 2004)
     
Olle Ludvigsson*
 
58
 
Director (since 1988). Deputy Director 1983 - 1988.
 
     
Johnny Rönnkvist*
 
59
 
Director (since 1999).
 
     
Berth Thulin*
 
55
 
Deputy Director (since 1999).
 
     
Margareta Öhlin*
 
59
 
Deputy Director (since 2005).
 
 
_____________________________
* Employee representative
 
51

 
At the Annual General Meeting on April 5, 2006, Haruko Fukuda and Patrick Faure left the Board of  Directors and Ying Yeh, Philippe Klein and Peter Bijur were elected as new Directors.